SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended January 31, 2005 |
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ______to ______ |
Commission file number 1-6089
H&R Block, Inc.
MISSOURI (State or other jurisdiction of incorporation or organization) | 44-0607856 (I.R.S. Employer Identification No.) |
4400 Main Street
Kansas City, Missouri 64111
(Address of principal executive offices, including zip code)
(816) 753-6900
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesüþ No ___o
The number of shares outstanding of the registrant’s Common Stock, without par value, at the close of business on November 30, 2004February 28, 2005 was 164,718,239165,256,051 shares.
H&R BLOCK, INC.
Form 10-Q for the Period Ended OctoberJanuary 31, 20042005
Table of Contents
Page | ||||||
PART I | Financial Information | |||||
Condensed Consolidated Balance Sheets January 31, | 1 | |||||
Condensed Consolidated Income Statements Three and | 2 | |||||
Condensed Consolidated Statements of Cash Flows Nine Months Ended | 3 | |||||
Notes to Condensed Consolidated Financial Statements | 4 | |||||
Management’s Discussion and Analysis of Results of Operations and Financial Condition | ||||||
Quantitative and Qualitative Disclosures about Market Risk | 39 | |||||
Controls and Procedures | 39 | |||||
Other Information | 40 | |||||
45 |
H&R BLOCK, INC.
January 31, | April 30, | |||||||||||||||
October 31, | April 30, | 2005 | 2004 | |||||||||||||
2004 | 2004 | |||||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
ASSETS | ||||||||||||||||
Cash and cash equivalents | $ | 575,796 | $ | 1,071,676 | $ | 576,146 | $ | 1,071,676 | ||||||||
Cash and cash equivalents – restricted | 496,798 | 545,428 | 535,318 | 545,428 | ||||||||||||
Receivables from customers, brokers, dealers and clearing organizations, net | 610,039 | 625,076 | 623,225 | 625,076 | ||||||||||||
Receivables, net | 368,072 | 347,910 | 1,461,097 | 347,910 | ||||||||||||
Prepaid expenses and other current assets | 432,335 | 371,209 | 425,400 | 371,209 | ||||||||||||
Total current assets | 2,483,040 | 2,961,299 | 3,621,186 | 2,961,299 | ||||||||||||
Residual interests in securitizations – available-for-sale | 261,503 | 210,973 | 253,531 | 210,973 | ||||||||||||
Beneficial interest in Trusts – trading | 108,624 | 137,757 | 131,885 | 137,757 | ||||||||||||
Mortgage servicing rights | 134,062 | 113,821 | 147,511 | 113,821 | ||||||||||||
Property and equipment, at cost less accumulated depreciation and amortization of $621,587 and $579,535 | 275,688 | 279,220 | ||||||||||||||
Property and equipment, at cost less accumulated depreciation and amortization of $642,536 and $579,535 | 327,385 | 279,220 | ||||||||||||||
Intangible assets, net | 299,851 | 325,829 | 295,260 | 325,829 | ||||||||||||
Goodwill, net | 964,548 | 959,418 | 975,850 | 959,418 | ||||||||||||
Other assets | 369,542 | 391,709 | 388,513 | 391,709 | ||||||||||||
Total assets | $ | 4,896,858 | $ | 5,380,026 | $ | 6,141,121 | $ | 5,380,026 | ||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||||||
Liabilities: | ||||||||||||||||
Commercial paper | $ | 316,056 | $ | — | $ | 1,528,882 | $ | — | ||||||||
Current portion of long-term debt | 277,546 | 275,669 | 25,575 | 275,669 | ||||||||||||
Accounts payable to customers, brokers and dealers | 1,000,083 | 1,065,793 | 1,035,228 | 1,065,793 | ||||||||||||
Accounts payable, accrued expenses and other | 483,996 | 456,167 | ||||||||||||||
Accounts payable, accrued expenses and other current liabilities | 503,623 | 456,167 | ||||||||||||||
Accrued salaries, wages and payroll taxes | 115,249 | 268,747 | 230,251 | 268,747 | ||||||||||||
Accrued income taxes | 88,784 | 405,667 | 78,796 | 405,667 | ||||||||||||
Total current liabilities | 2,281,714 | 2,472,043 | 3,402,355 | 2,472,043 | ||||||||||||
Long-term debt | 931,781 | 545,811 | 928,529 | 545,811 | ||||||||||||
Other noncurrent liabilities | 368,696 | 465,163 | 361,587 | 465,163 | ||||||||||||
Total liabilities | 3,582,191 | 3,483,017 | 4,692,471 | 3,483,017 | ||||||||||||
Stockholders’ equity: | ||||||||||||||||
Common stock, no par, stated value $.01 per share, 800,000,000 shares authorized, 217,945,398 shares issued at October 31, 2004 and April 30, 2004 | 2,179 | 2,179 | ||||||||||||||
Common stock, no par, stated value $.01 per share, 800,000,000 shares authorized, 217,945,398 shares issued at January 31, 2005 and April 30, 2004 | 2,179 | 2,179 | ||||||||||||||
Additional paid-in capital | 558,770 | 545,065 | 581,748 | 545,065 | ||||||||||||
Accumulated other comprehensive income | 99,589 | 57,953 | 97,625 | 57,953 | ||||||||||||
Retained earnings | 2,615,089 | 2,781,368 | 2,670,356 | 2,781,368 | ||||||||||||
Less cost of 54,469,436 and 44,849,128 shares of common stock in treasury | (1,960,960 | ) | (1,489,556 | ) | ||||||||||||
Less cost of 52,864,620 and 44,849,128 shares of common stock in treasury | (1,903,258 | ) | (1,489,556 | ) | ||||||||||||
Total stockholders’ equity | 1,314,667 | 1,897,009 | 1,448,650 | 1,897,009 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 4,896,858 | $ | 5,380,026 | $ | 6,141,121 | $ | 5,380,026 | ||||||||
See Notes to Condensed Consolidated Financial Statements
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H&R BLOCK, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
Three months ended | Nine months ended | |||||||||||||||||||||||||||||||
January 31, | January 31, | |||||||||||||||||||||||||||||||
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
October 31, | October 31, | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||||||
Service revenues | $ | 277,289 | $ | 247,740 | $ | 517,046 | $ | 462,698 | $ | 656,871 | $ | 572,862 | $ | 1,195,353 | $ | 1,053,056 | ||||||||||||||||
Gains on sales of mortgage loans, net | 184,555 | 250,558 | 366,648 | 459,955 | ||||||||||||||||||||||||||||
Gains on sales of mortgage assets, net | 198,302 | 212,249 | 564,950 | 672,204 | ||||||||||||||||||||||||||||
Interest income | 45,889 | 46,615 | 82,593 | 90,503 | 46,599 | 59,328 | 129,192 | 149,831 | ||||||||||||||||||||||||
Other | 31,522 | 23,959 | 55,679 | 51,100 | 130,235 | 118,391 | 164,478 | 151,995 | ||||||||||||||||||||||||
1,032,007 | 962,830 | 2,053,973 | 2,027,086 | |||||||||||||||||||||||||||||
539,255 | 568,872 | 1,021,966 | 1,064,256 | |||||||||||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||||||||||
Cost of services | 318,833 | 282,926 | 608,035 | 534,577 | 509,104 | 454,342 | 1,124,894 | 991,587 | ||||||||||||||||||||||||
Interest | 21,063 | 19,899 | 40,153 | 43,096 | 24,927 | 21,361 | 65,080 | 64,457 | ||||||||||||||||||||||||
Selling, general and administrative | 286,793 | 250,077 | 535,784 | 453,479 | 366,025 | 312,623 | 894,054 | 763,434 | ||||||||||||||||||||||||
626,689 | 552,902 | 1,183,972 | 1,031,152 | 900,056 | 788,326 | 2,084,028 | 1,819,478 | |||||||||||||||||||||||||
Operating income (loss) | (87,434 | ) | 15,970 | (162,006 | ) | 33,104 | 131,951 | 174,504 | (30,055 | ) | 207,608 | |||||||||||||||||||||
Other income, net | 1,510 | 1,164 | 3,518 | 2,859 | 19,732 | 1,616 | 23,250 | 4,475 | ||||||||||||||||||||||||
Income (loss) before taxes | (85,924 | ) | 17,134 | (158,488 | ) | 35,963 | 151,683 | 176,120 | (6,805 | ) | 212,083 | |||||||||||||||||||||
Income taxes (benefit) | (33,725 | ) | 6,758 | (62,206 | ) | 14,068 | 59,991 | 69,394 | (2,215 | ) | 83,462 | |||||||||||||||||||||
Net income (loss) before cumulative effect of change in accounting principle | (52,199 | ) | 10,376 | (96,282 | ) | 21,895 | 91,692 | 106,726 | (4,590 | ) | 128,621 | |||||||||||||||||||||
Cumulative effect of change in accounting principle for multiple deliverable revenue arrangements, less tax benefit of $4,031 | — | — | — | (6,359 | ) | — | — | — | (6,359 | ) | ||||||||||||||||||||||
Net income (loss) | $ | (52,199 | ) | $ | 10,376 | $ | (96,282 | ) | $ | 15,536 | $ | 91,692 | $ | 106,726 | $ | (4,590 | ) | $ | 122,262 | |||||||||||||
Basic earnings (loss) per share: | ||||||||||||||||||||||||||||||||
Before change in accounting principle | $ | (.32 | ) | $ | .06 | $ | (.58 | ) | $ | .12 | $ | .56 | $ | .60 | $ | (.03 | ) | $ | .72 | |||||||||||||
Cumulative effect of change in accounting principle | — | — | — | (.03 | ) | — | — | — | (.03 | ) | ||||||||||||||||||||||
Net income (loss) | $ | (.32 | ) | $ | .06 | $ | (.58 | ) | $ | .09 | $ | .56 | $ | .60 | $ | (.03 | ) | $ | .69 | |||||||||||||
Diluted earnings (loss) per share: | ||||||||||||||||||||||||||||||||
Before change in accounting principle | $ | (.32 | ) | $ | .06 | $ | (.58 | ) | $ | .12 | $ | .55 | $ | .59 | $ | (.03 | ) | $ | .71 | |||||||||||||
Cumulative effect of change in accounting principle | — | — | — | (.03 | ) | — | — | — | (.04 | ) | ||||||||||||||||||||||
Net income (loss) | $ | (.32 | ) | $ | .06 | $ | (.58 | ) | $ | .09 | $ | .55 | $ | .59 | $ | (.03 | ) | $ | .67 | |||||||||||||
Dividends per share | $ | .22 | $ | .20 | $ | .42 | $ | .38 | $ | .22 | $ | .20 | $ | .64 | $ | .58 | ||||||||||||||||
See Notes to Condensed Consolidated Financial Statements
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H&R BLOCK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended October 31, | 2004 | 2003 | ||||||||||||||
Nine months ended January 31, | 2005 | 2004 | ||||||||||||||
Cash flows from operating activities: | ||||||||||||||||
Net income (loss) | $ | (96,282 | ) | $ | 15,536 | $ | (4,590 | ) | $ | 122,262 | ||||||
Adjustments to reconcile net income (loss) to net cash used in operating activities: | ||||||||||||||||
Depreciation and amortization | 76,768 | 76,010 | 122,305 | 122,497 | ||||||||||||
Accretion of residual interests in securitizations | (57,835 | ) | (70,906 | ) | (86,618 | ) | (118,389 | ) | ||||||||
Impairments of residual interests in securitizations | 3,469 | 11,106 | 8,304 | 26,048 | ||||||||||||
Additions to trading securities — residual interests in securitizations | (68,618 | ) | (199,021 | ) | ||||||||||||
Additions to trading securities – residual interests in securitizations | (115,213 | ) | (251,585 | ) | ||||||||||||
Proceeds from net interest margin transactions, net | 53,348 | 147,107 | 98,743 | 197,417 | ||||||||||||
Additions to mortgage servicing rights | (58,894 | ) | (48,002 | ) | (94,569 | ) | (64,265 | ) | ||||||||
Amortization of mortgage servicing rights | 38,653 | 35,307 | 60,879 | 57,334 | ||||||||||||
Net change in beneficial interest in Trusts | 29,133 | (62,823 | ) | 5,872 | (5,406 | ) | ||||||||||
Other, net of acquisitions | (594,829 | ) | (367,664 | ) | (1,580,364 | ) | (1,087,553 | ) | ||||||||
Net cash used in operating activities | (675,087 | ) | (463,350 | ) | (1,585,251 | ) | (1,001,640 | ) | ||||||||
Cash flows from investing activities: | ||||||||||||||||
Cash received from residual interests in securitizations | 73,477 | 68,850 | 100,344 | 127,997 | ||||||||||||
Purchases of property and equipment, net | (55,249 | ) | (43,591 | ) | (137,483 | ) | (81,178 | ) | ||||||||
Payments made for business acquisitions, net of cash acquired | (5,472 | ) | (123,337 | ) | (26,348 | ) | (280,280 | ) | ||||||||
Other, net | 12,138 | 6,691 | 15,207 | 36,052 | ||||||||||||
Net cash provided by (used in) investing activities | 24,894 | (91,387 | ) | |||||||||||||
Net cash used in investing activities | (48,280 | ) | (197,409 | ) | ||||||||||||
Cash flows from financing activities: | ||||||||||||||||
Repayments of commercial paper | (1,376,877 | ) | (499,771 | ) | (2,348,966 | ) | (1,022,716 | ) | ||||||||
Proceeds from issuance of commercial paper | 1,692,933 | 624,401 | 3,877,848 | 2,433,893 | ||||||||||||
Proceeds from issuance of long-term debt, net | 395,221 | — | ||||||||||||||
Repayments of Senior Notes | (250,000 | ) | — | |||||||||||||
Proceeds from issuance of Senior Notes, net | 395,221 | — | ||||||||||||||
Proceeds from securitization financing | — | 50,100 | — | 50,100 | ||||||||||||
Repayments of securitization financing | — | (50,100 | ) | |||||||||||||
Payments on acquisition debt | (11,605 | ) | (45,100 | ) | (19,462 | ) | (50,820 | ) | ||||||||
Dividends paid | (69,997 | ) | (68,087 | ) | (106,422 | ) | (103,538 | ) | ||||||||
Acquisition of treasury shares | (529,558 | ) | (178,847 | ) | (529,852 | ) | (371,242 | ) | ||||||||
Proceeds from issuance of common stock | 53,933 | 59,851 | 119,892 | 111,155 | ||||||||||||
Other, net | 263 | (1,833 | ) | (258 | ) | (1,947 | ) | |||||||||
Net cash provided by (used in) financing activities | 154,313 | (59,286 | ) | |||||||||||||
Net cash provided by financing activities | 1,138,001 | 994,785 | ||||||||||||||
Net decrease in cash and cash equivalents | (495,880 | ) | (614,023 | ) | (495,530 | ) | (204,264 | ) | ||||||||
Cash and cash equivalents at beginning of the period | 1,071,676 | 875,353 | 1,071,676 | 875,353 | ||||||||||||
Cash and cash equivalents at end of the period | $ | 575,796 | $ | 261,330 | $ | 576,146 | $ | 671,089 | ||||||||
See Notes to Condensed Consolidated Financial Statements
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1. | Basis of Presentation |
The condensed consolidated balance sheet as of January 31, 2005, the condensed consolidated income statements for the three and nine months ended January 31, 2005 and 2004, and the condensed consolidated statements of cash flows for the nine months ended January 31, 2005 and 2004 have been prepared by the Company, without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows at January 31, 2005 and for all periods presented have been made.
“H&R Block,” “the Company,” “we,” “our” and “us” are used interchangeably to refer to H&R Block, Inc. or to H&R Block, Inc. and its subsidiaries, as appropriate to the context.
Certain reclassifications have been made to prior year amounts to conform to the current year presentation. Most notably, we reclassified $57.6 million and $125.9 million previously reported as interest income to gains on sales of mortgage assets for the three and nine months ended January 31, 2004, respectively. These reclassifications had no effect on our results of operations or stockholders’ equity as previously reported.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in our April 30, 2004 Annual Report to Shareholders on Form 10-K and our October 31, 2004 and July 31, 2004 Forms 10-Q.
Operating revenues of the Tax Services and Business Services segments are seasonal in nature with peak revenues occurring in the months of January through April. Therefore, results for interim periods are not indicative of results to be expected for the full year.
We file our Federal and state income tax returns on a calendar year basis. The condensed consolidated income statements reflect the effective tax rates expected to be applicable for the respective full fiscal years.
2. | Earnings (Loss) Per Share |
Basic earnings (loss) per share is computed using the weighted average shares outstanding during each period. The dilutive effect of potential common shares is included in diluted earnings (loss) per share except in those periods with a loss. The computations of basic and diluted earnings (loss) per share are as follows:
(in 000s, except per share amounts) | ||||||||||||||||
Three months ended | Nine months ended | |||||||||||||||
January 31, | January 31, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Net income (loss) before change in accounting principle | $ | 91,692 | $ | 106,726 | $ | (4,590 | ) | $ | 128,621 | |||||||
Basic weighted average common shares | 164,520 | 176,732 | 165,948 | 177,964 | ||||||||||||
Potential dilutive shares from stock options and restricted stock | 2,917 | 4,251 | — | 3,516 | ||||||||||||
Convertible preferred stock | 1 | 1 | — | 1 | ||||||||||||
Dilutive weighted average common shares | 167,438 | 180,984 | 165,948 | 181,481 | ||||||||||||
Earnings (loss) per share before change in accounting principle: | ||||||||||||||||
Basic | $ | .56 | $ | .60 | $ | (.03 | ) | $ | .72 | |||||||
Diluted | .55 | .59 | (.03 | ) | .71 | |||||||||||
Diluted earnings per share excludes the impact of shares of common stock issuable upon the lapse of certain restrictions or the exercise of options to purchase 15.2 million shares of stock for the nine months ended January 31, 2005, as the effect would be antidilutive due to the net loss recorded during the period. Diluted earnings per share for the three months ended January 31, 2005 and the three and nine months ended January 31, 2004 excludes the impact of 0.3 million, 283 and 3.7 million shares, respectively, issuable upon the exercise of stock options, as the effect would be antidilutive due to the
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options’ exercise prices being greater than the average market price of the common shares during the period.
The weighted average shares outstanding for the three and nine months ended January 31, 2005 decreased to 164.5 million and 165.9 million, respectively, from 176.7 million and 178.0 million last year, respectively, primarily due to our purchases of treasury shares. The effect of these purchases was partially offset by the issuance of treasury shares related to our stock-based compensation plans.
During the nine months ended January 31, 2005 and 2004, we issued 3.3 million shares and 3.8 million shares, respectively, of common stock pursuant to the exercise of stock options, employee stock purchases and awards of restricted shares, in accordance with our stock-based compensation plans.
During the nine months ended January 31, 2005, we acquired 11.3 million shares of our common stock, of which 11.2 million shares were purchased from third parties with the remaining shares swapped or surrendered to us, at an aggregate cost of $529.9 million. During the nine months ended January 31, 2004, we acquired 7.8 million shares of our common stock from third parties at an aggregate cost of $371.2 million.
3. | Receivables | |||
(in 000s, except per share amounts)
Three months ended | Six months ended | |||||||||||||||
October 31, | October 31, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
Net income (loss) before change in accounting principle | $ | (52,199 | ) | $ | 10,376 | $ | (96,282 | ) | $ | 21,895 | ||||||
Basic weighted average common shares | 164,686 | 177,828 | 166,721 | 178,616 | ||||||||||||
Dilutive potential shares from stock options and restricted stock | — | 3,282 | — | 3,348 | ||||||||||||
Convertible preferred stock | — | 1 | — | 1 | ||||||||||||
Dilutive weighted average common shares | 164,686 | 181,111 | 166,721 | 181,965 | ||||||||||||
Earnings (loss) per share before change in accounting principle: | ||||||||||||||||
Basic and diluted | $ | (.32 | ) | $ | .06 | $ | (.58 | ) | $ | .12 |
(in 000s) | ||||||||||||
January 31, 2005 | January 31, 2004 | April 30, 2004 | ||||||||||
Participation in refund anticipation loans (RALs) | $ | 829,325 | $ | 562,974 | $ | 49,047 | ||||||
Business Services accounts receivable | 175,140 | 153,322 | 145,231 | |||||||||
Mortgage loans held for sale | 128,607 | 113,388 | 64,136 | |||||||||
Receivables for tax-related fees | 108,331 | 79,287 | 4,900 | |||||||||
Loans to franchisees | 52,712 | 46,729 | 35,872 | |||||||||
Royalties from franchisees | 46,900 | 39,898 | 725 | |||||||||
Software receivables | 26,420 | 25,995 | 20,882 | |||||||||
Other | 126,643 | 111,801 | 80,535 | |||||||||
1,494,078 | 1,133,394 | 401,328 | ||||||||||
Allowance for doubtful accounts | (21,336 | ) | (23,903 | ) | (38,266 | ) | ||||||
Lower of cost or market adjustment – mortgage loans | (11,645 | ) | (16,440 | ) | (15,152 | ) | ||||||
$ | 1,461,097 | $ | 1,093,051 | $ | 347,910 | |||||||
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4. | Mortgage Banking Activities | |||
Activity related to available-for-sale residual interests in securitizations consists of the following: |
(in 000s)
Six months ended October 31, | 2004 | 2003 | ||||||||||||||
(in 000s) | ||||||||||||||||
Nine months ended January 31, | 2005 | 2004 | ||||||||||||||
Balance, beginning of period | $ | 210,973 | $ | 264,337 | $ | 210,973 | $ | 264,337 | ||||||||
Additions from net interest margin (NIM) transactions | 15,270 | 1,814 | 16,470 | 1,604 | ||||||||||||
Additions from NIM secured financing, held as collateral | — | 40,196 | ||||||||||||||
Cash received | (73,477 | ) | (68,850 | ) | (100,344 | ) | (127,997 | ) | ||||||||
Cash received from sale of previously securitized residuals | — | (17,000 | ) | |||||||||||||
Accretion | 57,835 | 70,906 | 86,618 | 118,389 | ||||||||||||
Impairments of fair value | (3,469 | ) | (11,106 | ) | (8,304 | ) | (26,048 | ) | ||||||||
Other | — | (2,603 | ) | (4 | ) | (5,875 | ) | |||||||||
Changes in unrealized holding gains arising during the period, net | 54,371 | 22,910 | 48,122 | 26,441 | ||||||||||||
Balance, end of period | $ | 261,503 | $ | 317,604 | $ | 253,531 | $ | 233,851 | ||||||||
Trading residual interests valued at $115.2 million and $199.0 million were securitized in NIM transactions during the nine months ended January 31, 2005 and 2004, respectively, with net cash proceeds of $98.7 million and $197.4 million received, respectively. In the prior year, additional residual interests were sold and cash proceeds of $50.1 million were received as a result of a secured financing (on-balance sheet securitization). During the third quarter of last year, the NIM trust was terminated and the related residual interests were subsequently securitized in a NIM transaction with a qualifying
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( Cash flows of $100.3 million and $128.0 million were received from the securitization trusts for the nine months ended January 31, 2005 and 2004, respectively. Cash received on residual interests is included in 000s)investing activities in the condensed consolidated statements of cash flows.
Aggregate net unrealized gains on residual interests, which had not yet been accreted into income, totaled $160.4 million at January 31, 2005 and $112.5 million at April 30, 2004. 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 or sale of the related residual interest.
Activity related to mortgage servicing rights (MSRs) consists of the following:
Six months ended October 31, | 2004 | 2003 | ||||||||||||||
(in 000s) | ||||||||||||||||
Nine months ended January 31, | 2005 | 2004 | ||||||||||||||
Balance, beginning of period | $ | 113,821 | $ | 99,265 | $ | 113,821 | $ | 99,265 | ||||||||
Additions | 58,894 | 48,002 | 94,569 | 64,265 | ||||||||||||
Amortization | (38,653 | ) | (35,307 | ) | (60,879 | ) | (57,334 | ) | ||||||||
Balance, end of period | $ | 134,062 | $ | 111,960 | $ | 147,511 | $ | 106,196 | ||||||||
Estimated amortization of MSRs for fiscal years 2005 through 2009 is $84.6 million, $70.2 million, $35.4 million, $13.8 million and $3.6 million, respectively. The key assumptions we used to estimate the cash flows and values of the residual interests initially recorded during the three months ended January 31, 2005 | ||||
October 31, 2004 | October 31, 2003 | |||||||||||
Estimated annual prepayments | 0.11% to 83.22% | 30% to 90% | ||||||||||
January 31, 2005 | January 31, 2004 | |||||||||||
Estimated credit losses | 3.08% | 4.74% | 2.42 | % | 4.72 | % | ||||||
Discount rate | 25% | 13.21% | 25 | % | 21 | % | ||||||
Variable returns to third-party beneficial interest holders | LIBOR forward curve at closing | LIBOR forward curve at closing | ||||||||||
October 31, 2004 | April 30, 2004 | |||||||||||
Estimated annual prepayments | 0.37% to 93.36% | 25% to 90% | ||||||||||
January 31, 2005 | April 30, 2004 | |||||||||||
Estimated credit losses – residual interests | 3.25% | 4.16% | 3.08 | % | 4.16 | % | ||||||
Discount rate – residual interests | 20.93% | 19.09% | 20.37 | % | 19.09 | % | ||||||
Discount rate – MSRs | 12.80% | 12.80% | 12.80 | % | 12.80 | % | ||||||
Variable returns to third-party beneficial interest holders | LIBOR forward curve at valuation date | LIBOR forward curve at valuation date | ||||||||||
Mortgage Loans Securitized in Fiscal Year | ||||||||||||||||||||
Prior to 2002 | 2002 | 2003 | 2004 | 2005 | ||||||||||||||||
As of: | ||||||||||||||||||||
April 30, 2004 | 4.46 | % | 3.58 | % | 4.35 | % | 3.92 | % | — | |||||||||||
July 31, 2004 | 4.58 | % | 2.96 | % | 2.47 | % | 2.59 | % | — | |||||||||||
October 31, 2004 | 4.54 | % | 2.96 | % | 2.30 | % | 2.62 | % | 3.08 | % |
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Expected static pool credit losses are as follows:
Mortgage Loans Securitized in Fiscal Year | ||||||||||||||||||||
Prior to 2002 | 2002 | 2003 | 2004 | 2005 | ||||||||||||||||
As of: | ||||||||||||||||||||
April 30, 2004 | 4.46 | % | 3.58 | % | 4.35 | % | 3.92 | % | — | |||||||||||
July 31, 2004 | 4.58 | % | 2.96 | % | 2.47 | % | 2.59 | % | — | |||||||||||
October 31, 2004 | 4.54 | % | 2.96 | % | 2.30 | % | 2.62 | % | 3.08 | % | ||||||||||
January 31, 2005 | 4.54 | % | 2.57 | % | 2.10 | % | 2.42 | % | 2.73 | % |
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 outstanding at January 31, 2005, October 31, 2004, July 31, 2004 and April 30, 2004.
At January 31, 2005, the sensitivities of the current fair value of the residual interests and MSRs to 10% and 20% adverse changes in the above key assumptions are as follows:
(dollars in 000s) | ||||||||||||
Residential Mortgage Loans | ||||||||||||
NIM | Beneficial Interest | Servicing | ||||||||||
Residuals | in Trusts | Asset | ||||||||||
Carrying amount/fair value | $ | 253,531 | $ | 131,885 | $ | 147,511 | ||||||
Weighted average remaining life (in years) | 1.2 | 2.3 | 1.2 | |||||||||
Prepayments (including defaults): | ||||||||||||
Adverse 10% – $impact on fair value | $ | 62 | $ | (10,323 | ) | $ | (21,253 | ) | ||||
Adverse 20% – $impact on fair value | 6,717 | (16,485 | ) | (37,045 | ) | |||||||
Credit losses: | ||||||||||||
Adverse 10% – $impact on fair value | $ | (35,301 | ) | $ | (5,418 | ) | Not applicable | |||||
Adverse 20% – $impact on fair value | (69,779 | ) | (10,830 | ) | Not applicable | |||||||
Discount rate: | ||||||||||||
Adverse 10% – $impact on fair value | $ | (5,600 | ) | $ | (3,084 | ) | $ | (1,919 | ) | |||
Adverse 20% – $impact on fair value | (10,946 | ) | (8,827 | ) | (3,795 | ) | ||||||
Variable interest rates (LIBOR forward curve): | ||||||||||||
Adverse 10% – $impact on fair value | $ | (7,802 | ) | $ | (25,547 | ) | Not applicable | |||||
Adverse 20% – $impact on fair value | (15,295 | ) | (51,073 | ) | Not applicable | |||||||
These sensitivities are hypothetical and should be used with caution. 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 is calculated without changing any other assumptions. It is likely that changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.
Mortgage loans that have been securitized at January 31, 2005 and April 30, 2004, past due sixty days or more and the related credit losses incurred are presented below:
(in 000s) | ||||||||||||||||||||||||
Total Principal | Principal Amount of | |||||||||||||||||||||||
Amount of Loans | Loans 60 Days or | Credit Losses | ||||||||||||||||||||||
Outstanding | More Past Due | (net of recoveries) | ||||||||||||||||||||||
January 31, | April 30, | January 31, | April 30, | Three months ended | ||||||||||||||||||||
2005 | 2004 | 2005 | 2004 | January 31, 2005 | April 30, 2004 | |||||||||||||||||||
Securitized mortgage loans | $ | 11,863,950 | $ | 15,732,953 | $ | 1,190,385 | $ | 1,286,069 | $ | 110,374 | $ | 46,606 | ||||||||||||
Mortgage loans in warehouse Trusts | 5,243,654 | 3,244,141 | — | — | — | — | ||||||||||||||||||
Total loans | $ | 17,107,604 | $ | 18,977,094 | $ | 1,190,385 | $ | 1,286,069 | $ | 110,374 | $ | 46,606 | ||||||||||||
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(dollars in 000s)
Residential Mortgage Loans | ||||||||||||
NIM | Beneficial Interest | Servicing | ||||||||||
Residuals | in Trusts(1) | Asset | ||||||||||
Carrying amount/fair value | $ | 261,503 | $ | 108,624 | $ | 134,062 | ||||||
Weighted average remaining life (in years) | 1.2 | 2.6 | 1.3 | |||||||||
Prepayments (including defaults): | ||||||||||||
Adverse 10% — $ impact on fair value | $ | (3,887 | ) | $ | (13,805 | ) | $ | (13,455 | ) | |||
Adverse 20% — $ impact on fair value | (3,669 | ) | (20,687 | ) | (23,030 | ) | ||||||
Credit losses: | ||||||||||||
Adverse 10% — $ impact on fair value | $ | (34,773 | ) | $ | (5,782 | ) | Not applicable | |||||
Adverse 20% — $ impact on fair value | (69,504 | ) | (11,481 | ) | Not applicable | |||||||
Discount rate: | ||||||||||||
Adverse 10% — $ impact on fair value | $ | (5,187 | ) | $ | (5,879 | ) | $ | (1,738 | ) | |||
Adverse 20% — $ impact on fair value | (10,159 | ) | (11,294 | ) | (3,437 | ) | ||||||
Variable interest rates (LIBOR forward curve): | ||||||||||||
Adverse 10% — $ impact on fair value | $ | (7,539 | ) | $ | (15,455 | ) | Not applicable | |||||
Adverse 20% — $ impact on fair value | (14,086 | ) | (30,873 | ) | Not applicable |
(in 000s)5. Total Principal Principal Amount of Amount of Loans Loans 60 Days or Credit Losses Outstanding More Past Due (net of recoveries) October 31, April 30, October 31, April 30, Three months ended 2004 2004 2004 2004 October 31, 2004 April 30, 2004 Securitized mortgage loans $ 12,485,799 $ 15,732,953 $ 1,193,569 $ 1,286,069 $ 80,826 $ 46,606 Mortgage loans in warehouse Trusts 3,902,317 3,244,141 — — — —
Total loans $ 16,388,116 $ 18,977,094 $ 1,193,569 $ 1,286,069 $ 80,826 $ 46,606
Goodwill and Intangible Assets | ||||
(Changes in 000s)the carrying amount of goodwill for the nine months ended January 31, 2005, consist of the following:
(in 000s) | ||||||||||||||||||||||||||||||||
April 30, 2004 | Additions | Other | January 31, 2005 | |||||||||||||||||||||||||||||
April 30, 2004 | Additions | Other | October 31, 2004 | |||||||||||||||||||||||||||||
Tax Services | $ | 349,836 | $ | 1,604 | $ | 528 | $ | 351,968 | $ | 350,044 | $ | 9,512 | $ | 557 | $ | 360,113 | ||||||||||||||||
Mortgage Services | 152,467 | — | — | 152,467 | 152,467 | — | — | 152,467 | ||||||||||||||||||||||||
Business Services | 311,175 | 2,998 | — | 314,173 | 311,175 | 6,365 | (2 | ) | 317,538 | |||||||||||||||||||||||
Investment Services | 145,732 | — | — | 145,732 | 145,732 | — | — | 145,732 | ||||||||||||||||||||||||
Corporate | 208 | — | — | 208 | ||||||||||||||||||||||||||||
Total goodwill | $ | 959,418 | $ | 4,602 | $ | 528 | $ | 964,548 | $ | 959,418 | $ | 15,877 | $ | 555 | $ | 975,850 | ||||||||||||||||
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Intangible assets consist of the following:
(in 000s)
(in 000s) | ||||||||||||||||||||||||||||||||||||||||||||||||
January 31, 2005 | April 30, 2004 | |||||||||||||||||||||||||||||||||||||||||||||||
October 31, 2004 | April 30, 2004 | Gross | Gross | |||||||||||||||||||||||||||||||||||||||||||||
Gross | Gross | Carrying | Accumulated | Carrying | Accumulated | |||||||||||||||||||||||||||||||||||||||||||
Carrying | Accumulated | Carrying | Accumulated | Amount | Amortization | Net | Amount | Amortization | Net | |||||||||||||||||||||||||||||||||||||||
Amount | Amortization | Net | Amount | Amortization | Net | |||||||||||||||||||||||||||||||||||||||||||
Tax Services: | ||||||||||||||||||||||||||||||||||||||||||||||||
Customer relationships | $ | 18,964 | $ | (4,759 | ) | $ | 14,205$ | 18,167 | $ | (3,311 | ) | $ | 14,856 | $ | 23,717 | $ | (5,998 | ) | $ | 17,719 | $ | 19,011 | $ | (3,377 | ) | $ | 15,634 | |||||||||||||||||||||
Noncompete agreements | 17,164 | (8,539 | ) | 8,625 | 17,069 | (5,690 | ) | 11,379 | 17,677 | (10,098 | ) | 7,579 | 17,364 | (5,724 | ) | 11,640 | ||||||||||||||||||||||||||||||||
Business Services: | ||||||||||||||||||||||||||||||||||||||||||||||||
Customer relationships | 121,094 | (62,530 | ) | 58,564 | 121,229 | (56,313 | ) | 64,916 | 125,780 | (65,572 | ) | 60,208 | 121,229 | (56,313 | ) | 64,916 | ||||||||||||||||||||||||||||||||
Noncompete agreements | 27,375 | (9,965 | ) | 17,410 | 27,424 | (8,670 | ) | 18,754 | 27,515 | (10,619 | ) | 16,896 | 27,424 | (8,670 | ) | 18,754 | ||||||||||||||||||||||||||||||||
Trade name – amortizing | 1,450 | (960 | ) | 490 | 1,450 | (926 | ) | 524 | 1,450 | (978 | ) | 472 | 1,450 | (926 | ) | 524 | ||||||||||||||||||||||||||||||||
Trade name – non-amortizing | 55,637 | (4,868 | ) | 50,769 | 55,637 | (4,868 | ) | 50,769 | 55,637 | (4,868 | ) | 50,769 | 55,637 | (4,868 | ) | 50,769 | ||||||||||||||||||||||||||||||||
Investment Services: | ||||||||||||||||||||||||||||||||||||||||||||||||
Customer relationships | 293,000 | (144,058 | ) | 148,942 | 293,000 | (129,408 | ) | 163,592 | 293,000 | (151,383 | ) | 141,617 | 293,000 | (129,408 | ) | 163,592 | ||||||||||||||||||||||||||||||||
Corporate: | ||||||||||||||||||||||||||||||||||||||||||||||||
Customer relationships | 844 | (217 | ) | 627 | 844 | (66 | ) | 778 | ||||||||||||||||||||||||||||||||||||||||
Noncompete agreements | 295 | (76 | ) | 219 | 295 | (34 | ) | 261 | ||||||||||||||||||||||||||||||||||||||||
Total intangible assets | $ | 535,823 | $ | (235,972 | ) | $ | 299,851 | $ | 535,115 | $ | (209,286 | ) | $ | 325,829 | $ | 544,776 | $ | (249,516 | ) | $ | 295,260 | $ | 535,115 | $ | (209,286 | ) | $ | 325,829 | ||||||||||||||||||||
Amortization of intangible assets for the three and sixnine months ended OctoberJanuary 31, 20042005 was $13.5$13.6 million and $26.8$40.4 million, respectively. Amortization of intangible assets for the three and sixnine months ended OctoberJanuary 31, 20032004 was $12.9$15.3 million and $24.0$39.3 million, respectively. Estimated amortization of intangible assets for fiscal years 2005 through 2009 is $53.6$54.8 million, $51.9$53.3 million, $43.0$44.2 million, $41.2$42.3 million and $39.8$40.9 million, respectively.
The goodwill and intangible assets previously included in the Corporate segment as of April 30, 2004 have been reclassified to the Tax Services segment.
6. | Derivative Instruments | |||
A summary of our derivative instruments as of January 31, 2005 and April 30, 2004, and gains or losses incurred during the three and nine months ended January 31, 2005 and 2004 follows. We enter into derivative instruments to reduce risks relating to mortgage loans we originate and sell, and therefore all gains or losses are included in gains on sales of mortgage assets, net in the condensed consolidated income statements.
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instruments and are therefore not recorded in our financial statements. The notional value and the contract value of the forward commitments at October 31, 2004 were $3.1 billion and $3.2 billion, respectively. Most of our forward commitments give us the option to under- or over-deliver by five to ten percent.
(in 000s) | ||||||||||||||||||||||||
Asset (Liability) Balance at | Gain (Loss) in the Three | Gain (Loss) in the Nine | ||||||||||||||||||||||
January 31, | April 30, | Months Ended January 31, | Months Ended January 31, | |||||||||||||||||||||
2005 | 2004 | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||
Interest rate swaps | $ | 1,752 | $ | — | $ | 31,039 | $ | (2,703 | ) | $ | 28,934 | $ | (2,703 | ) | ||||||||||
Rate-lock equivalents | 455 | (1,386 | ) | 141 | (4,525 | ) | 1,841 | (3,911 | ) | |||||||||||||||
Prime short sales | (319 | ) | 2,080 | (424 | ) | (496 | ) | (1,949 | ) | 2,317 | ||||||||||||||
$ | 1,888 | $ | 694 | $ | 30,756 | $ | (7,724 | ) | $ | 28,826 | $ | (4,297 | ) | |||||||||||
We use interest rate swaps and forward loan sale commitments to reduce interest rate risk associated with non-prime loansloans. 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 commitments we expect to make in our pipeline prior to disposition of the loans.next 30 days. Interest rate swaps represent an agreement to exchange interest rate payments, effectively converting our fixed financing costs into a floating rate. These contracts increase in value as rates rise and decrease in value as rates fall.
Forward loan sale commitments for non-prime loans are not considered derivative instruments and are therefore not recorded in our financial statements. The swaps outstanding at October 31, 2004 included a net liability of $3.6 million, while no such swaps were outstanding at April 30, 2004. Changes innotional value and the marketcontract value of thesethe forward commitments at January 31, 2005 were $4.0 billion and $4.1 billion, respectively. Most of our forward commitments give us the option to under- or over-deliver by five to ten percent.
In the normal course of business, we enter into commitments with our customers to fund prime mortgage loans for specified periods of time at “locked-in” interest rates. These derivative instruments are included in gains on salesrepresent commitments (rate-lock equivalents) to fund prime loans. We adopted SEC Staff Accounting Bulletin No. 105, “Application of mortgage assets and totaled a lossAccounting Principles to Loan Commitments,” as of $2.1 million for the three and six months ended OctoberMarch 31, 2004. There wereUpon adoption, we no such swaps outstandinglonger record an asset at October 31, 2003,the time we enter into the commitments to fund non-prime mortgage loans.
We sell short FNMA, FHLMC and therefore no incomeGNMA 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-rate mortgage loans is closed approximately 10-15 days prior to standard Public Securities Association (PSA) settlement dates.
7. | Long-Term Debt |
In August 2004 we filed an additional shelf registration statement impactwith the SEC for the three and six months ended October 31, 2003.
6. Long-Term Debt
up to $1.0 billion in debt securities. On October 26, 2004, we issued $400.0 million of 5.125% Senior Notes under a shelf registration statement.statements. The Senior Notes are due on October 30, 2014, and are not redeemable by the bondholders prior to maturity. The proceeds from the notes will bewere used to repay our $250.0 million in 63/6 3/4% Senior Notes, which were due on November 1, 2004. The remaining proceeds will bewere used for working capital, capital expenditures, repayment of other debt and other general corporate purposes. The proceeds are included in cash and cash equivalents on the condensed consolidated balance sheet at October 31, 2004.
7.
8. | Comprehensive Income |
The components of comprehensive income are:
(in 000s)
(in 000s) | ||||||||||||||||||||||||||||||||
Three months ended | Nine months ended | |||||||||||||||||||||||||||||||
January 31, | January 31, | |||||||||||||||||||||||||||||||
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
October 31, | October 31, | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||||||||
Net income (loss) | $ | (52,199 | ) | $ | 10,376 | $ | (96,282 | ) | $ | 15,536 | $ | 91,692 | $ | 106,726 | $ | (4,590 | ) | $ | 122,262 | |||||||||||||
Change in unrealized gain on marketable securities, net | 9,752 | (6,172 | ) | 33,595 | 14,036 | (3,881 | ) | (8,356 | ) | 29,714 | 5,680 | |||||||||||||||||||||
Change in foreign currency translation adjustments | 8,371 | 6,087 | 8,041 | 11,730 | 1,917 | 2,319 | 9,958 | 14,049 | ||||||||||||||||||||||||
Comprehensive income (loss) | $ | (34,076 | ) | $ | 10,291 | $ | (54,646 | ) | $ | 41,302 | ||||||||||||||||||||||
Comprehensive income | $ | 89,728 | $ | 100,689 | $ | 35,082 | $ | 141,991 | ||||||||||||||||||||||||
8.
9. | Stock-Based Compensation |
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), under the prospective transition method as described in Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” Had compensation cost for
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all stock-based compensation plan grants been determined in accordance with the fair value accounting method prescribed under SFAS 123, our net income (loss) and earnings (loss) per share would have been as follows:
(in 000s, except per share amounts)
(in 000s, except per share amounts) | ||||||||||||||||||||||||||||||||
Three months ended | Nine months ended | |||||||||||||||||||||||||||||||
January 31, | January 31, | |||||||||||||||||||||||||||||||
Three months ended | Six months ended | |||||||||||||||||||||||||||||||
October 31, | October 31, | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||||||||
Net income (loss) as reported | $ | (52,199 | ) | $ | 10,376 | $ | (96,282 | ) | $ | 15,536 | $ | 91,692 | $ | 106,726 | $ | (4,590 | ) | $ | 122,262 | |||||||||||||
Add: Stock-based compensation expense included in reported net income (loss), net of related tax effects | 5,242 | 2,005 | 8,342 | 2,797 | 8,918 | 4,733 | 17,260 | 7,530 | ||||||||||||||||||||||||
Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of related tax effects | (7,923 | ) | (5,565 | ) | (13,705 | ) | (10,631 | ) | (11,599 | ) | (7,132 | ) | (25,304 | ) | (17,763 | ) | ||||||||||||||||
Pro forma net income (loss) | $ | (54,880 | ) | $ | 6,816 | $ | (101,645 | ) | $ | 7,702 | $ | 89,011 | $ | 104,327 | $ | (12,634 | ) | $ | 112,029 | |||||||||||||
Basic and diluted earnings (loss) per share: | ||||||||||||||||||||||||||||||||
Basic earnings (loss) per share: | ||||||||||||||||||||||||||||||||
As reported | $ | (.32 | ) | $ | .06 | $ | (.58 | ) | $ | .09 | $ | .56 | $ | .60 | $ | (.03 | ) | $ | .69 | |||||||||||||
Pro forma | (.33 | ) | .04 | (.61 | ) | .04 | .54 | .59 | (.08 | ) | .63 | |||||||||||||||||||||
Diluted earnings (loss) per share: | ||||||||||||||||||||||||||||||||
As reported | $ | .55 | $ | .59 | $ | (.03 | ) | $ | .67 | |||||||||||||||||||||||
Pro forma | .53 | .58 | (.08 | ) | .62 | |||||||||||||||||||||||||||
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9.
10. | Supplemental Cash Flow Information |
During the sixnine months ended OctoberJanuary 31, 2004,2005, we paid $316.8$406.6 million and $37.3$53.6 million for income taxes and interest, respectively. During the sixnine months ended OctoberJanuary 31, 2003,2004, we paid $170.8$245.4 million and $42.7$57.5 million for income taxes and interest, respectively.
The following transactions were treated as non-cash investing activities in the condensed consolidated statement of cash flows:
(in 000s)
Six months ended October 31, | 2004 | 2003 | ||||||||||||||
(in 000s) | ||||||||||||||||
Nine months ended January 31, | 2005 | 2004 | ||||||||||||||
Residual interest mark-to-market | $ | 88,867 | $ | 22,910 | $ | 98,713 | $ | 24,731 | ||||||||
Additions to residual interests | 15,270 | 1,814 | 16,470 | 1,604 | ||||||||||||
Accrued payment on acquisition debt | — | 25,000 | ||||||||||||||
10.
11. | Commitments and Contingencies |
We maintain unsecured committed lines of credit (CLOCs) to support our commercial paper program and for general corporate purposes. During the second quarter, we replaced our $2.0 billion CLOC with two CLOCs. The two CLOCs are from a consortium of thirty-one banks. The first $1.0 billion CLOC is subject to annual renewal in August 2005, has a one-year term-out provision with a maturity date in August 2006 and has an annual facility fee of ten basis points per annum. The second $1.0 billion CLOC has a maturity date of August 2009 and has an annual facility fee of twelve basis points per annum. We obtained an additional $750.0 million line of credit for the period of January 26 to February 25, 2005 to back-up peak commercial paper issuance or use as an alternate source of funding for RAL participations. These lines are subject to various affirmative and negative covenants, including a minimum net worth covenant. These CLOCs were undrawn at January 31, 2005.
We offer guarantees under our Peace of Mind (POM) program to tax clients whereby we will assume the cost of additional taxes attributable to tax return preparation errorerrors for which we are responsible. In August 2003, we adopted Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21). EITF 00-21 impacts revenue and expense 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 and expenses related to POM guarantees at premium offices were recorded in the same period as tax preparation revenues. Beginning May 1, 2003, revenues and direct expenses related to POM guarantees are now initially deferred and recognized over the guarantee period based upon historic and actual payment of claims. 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. Changes in the deferred revenue liability are as follows:
(in 000s)
Six months ended October 31, | 2004 | 2003 | ||||||
Balance, beginning of period | $ | 123,048 | $ | 49,280 | ||||
Amounts deferred for new guarantees issued | 798 | 975 | ||||||
Revenue recognized on previous deferrals | (41,627 | ) | (37,558 | ) | ||||
Adjustment resulting from change in accounting principle | — | 61,487 | ||||||
Balance, end of period | $ | 82,219 | $ | 74,184 | ||||
(in 000s) | ||||||||
Nine months ended January 31, | 2005 | 2004 | ||||||
Balance, beginning of period | $ | 123,048 | $ | 49,280 | ||||
Amounts deferred for new guarantees issued | 19,925 | 19,098 | ||||||
Revenue recognized on previous deferrals | (52,295 | ) | (47,273 | ) | ||||
Adjustment resulting from change in accounting principle | — | 61,487 | ||||||
Balance, end of period | $ | 90,678 | $ | 82,592 | ||||
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 $2.7$3.2 billion and $2.6 billion at OctoberJanuary 31, 20042005 and April 30, 2004, respectively. External market forces impact the probability of commitments being exercised, and therefore, total commitments outstanding do not necessarily represent future cash requirements.
We have entered into whole loan sale agreements with investors in the normal course of business, which include standard representations and warranties customary to the mortgage banking industry. Violations of these representations and warranties may require us to repurchase loans previously sold. A liability has been established related to the potential loss on repurchase of loans previously sold of $36.0$36.9 million and $25.2 million at OctoberJanuary 31, 20042005 and April 30, 2004, respectively, based on historical experience. Repurchased loans are normally sold in subsequent sale transactions.
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Option One Mortgage Corporation 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. This guarantee would be called upon in the event adequate proceeds were not available from the sale of the mortgage loans to satisfy the 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 OctoberJanuary 31, 20042005 and April 30, 2004 was $3.8$5.3 billion and $3.2 billion, respectively. The fair value of mortgage loans held by the Trusts as of OctoberJanuary 31, 20042005 and April 30, 2004 was $3.9$5.4 billion and $3.3 billion, respectively.
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 $4.8$5.6 million and $7.8 million as of OctoberJanuary 31, 20042005 and April 30, 2004, respectively. Our estimate is based on current financial conditions. Should actual results differ materially from our assumptions, the potential payments will differ from the above estimate. Such payments, if and when paid, would be recorded as additional cost of the acquired business, generally goodwill.
We have contractual commitments to fund certain franchises requesting draws on Franchise Equity Lines of Credit (FELCs). Our commitment to fund FELCs as of OctoberJanuary 31, 20042005 and April 30, 2004 totaled $66.1$69.1 million and $27.0 million, respectively. We have a receivable of $42.6$52.7 million and $35.9 million, which represents the amounts drawn on the FELCs, as of OctoberJanuary 31, 20042005 and April 30, 2004, respectively.
We routinely enter into contracts that include embedded indemnifications that have characteristics similar to guarantees, including obligations to protect counter parties from losses arising from the following: (a) tax, legal and other risks related to the purchase or disposition of businesses; (b) penalties and interest assessed by Federal and state taxing authorities in connection with tax returns prepared for clients; (c) indemnification of our directors and officers; and (d) third-party claims relating to various arrangements in the normal course of business. Typically, there is no stated maximum payment related to these indemnifications, and the term of indemnities may vary and in many cases is limited only by the applicable statute of limitations. The likelihood of any claims being asserted against us and the ultimate liability related to any such claims, if any, is difficult to predict. While we cannot provide assurance that such claims will not be successfully asserted, we believe the fair value of these guarantees and indemnifications is not material as of OctoberJanuary 31, 2004.2005.
11. -11-
12. | Litigation Commitments and Contingencies |
We have been involved in a number of Refund Anticipation Loan (RAL) class actions and putative RAL class action cases since 1990.1990 regarding our RAL programs. These cases are based on a variety of legal theories and allegations. These theories and allegations include, among others, that (i) we improperly did not disclose license fees we received from RAL lending banks for RALs they make to our clients, (ii) we owe and breached a fiduciary duty to our clients, and (iii) the RAL program violates laws such as state credit service organization laws and the federal Racketeer Influenced and Corrupt Organizations (RICO) Act. Although we have successfully defended many suchRAL cases, we incurred a substantial pretax expense of $43.5 million in fiscal year 2003 in connection with the settlement of one suchRAL case. Several of thesethe RAL cases are still pending and the amounts claimed in some of them are very substantial. To avoidWe cannot estimate the uncertaintyrange of litigation and the diversion of resources and personnel resulting from the lawsuits, we, the lending bank, and the plaintiffs in the caseJoel E. Zawikowski, et al. v. Beneficial National Bank, H&R Block, Inc., et al.(renamedLynne A. Carnegie, et al. v. H&R Block, Inc., et al.), Case No. 98-C-2178 in the United States District Court for Northern Illinois, had agreed to a settlement class and a settlement of RAL-related claims on a nationwide basis. Under that settlement, we and the lending bank agreed to each pay $12.5 million toward a $25.0 million settlement fund for the benefit of the class members. The settlement was approved by the District Court in February 2001. Certain class members who had objectedpossible loss relating to the settlement appealed the order approving the settlement to the Seventh Circuit CourtRAL cases in light of Appeals. In April 2002, the Court of Appeals reversed the District Court’s order approving the settlement and remanded the matter back to the District Court for further consideration of the fairness and adequacy of the proposed settlement by a new District Court judge. In April 2003, the District Court judge declined to approve the $25.0 million settlement, finding that counsel for the settlement plaintiffs had been inadequate representatives of the plaintiff class and failed to sustain their burden of showingvarious legal uncertainties. However, it is reasonably possible that the settlement was fair. The judge subsequently appointed new counsel for the plaintiffs who filed an amended complaint and a motion for partial summary judgment. In March 2004, the court either dismissed or decertified allultimate cost of the plaintiffs’ claims other than part of one count alleging violations of the racketeering and conspiracy provision of the Racketeer Influenced and Corrupt Organizations act.
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The case is currently scheduled to go to trial in March 2005.this litigation could be substantial. We intend to continue defending the case and the remaining RAL class action litigationcases vigorously, butalthough there are no assurances as to their outcome.
On September 8, 2004, our Board of Directors approved a proposed settlement of the caseJoyce Green, et al. v. H&R Block, Inc., Block Financial Corporation, et al.,Case No. 97195023, in the Circuit Court for Baltimore City, Maryland. The proposed settlement provided for each class member to receive a small cash payment and a one-time rebate coupon for tax return preparation services and for the defendants to pay settlement administration costs and court-approved legal fees of class counsel. During the process of finalizing the settlement agreement, the parties were unable to reach agreement regarding certain settlement terms. We intend to continue defending the case vigorously, but there is no assurance as to its outcome.
In addition to the aforementioned cases, we have from time to time beenare also parties to claims and lawsuits arising out ofpertaining to our business operations.electronic tax return filing services and our POM guarantee program associated with income tax preparation 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. SomeWe intend to continue defending these cases vigorously, although there are no assurances as to their outcome.
In addition to the aforementioned types of these claims and lawsuits pertaincases, we are parties to RALs and our Peace of Mind guarantee program associated with income tax preparation services. Others are claims and lawsuits that we consider to be ordinary, routine litigationdisputes incidental to our business (“Other Claims”)(Other Claims and Lawsuits), including claims and lawsuits concerning the preparation of customers’ income tax returns, the electronic filing of income tax returns, the fees charged customers for various services, the Express IRA program,investment products, relationships with franchisees, contract disputes and civil actions, arbitrations, regulatory inquiries and class actions arising out of our business as a broker-dealer and as a servicer of mortgage loans. We believe we have meritorious defenses to each of the Other Claims and Lawsuits 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 that amounts, if any, required to be paid by us in the discharge of liabilities or settlements pertaining to Other Claims and Lawsuits will not have a material adverse effect on our consolidated results of operations, cash flows or financial position.statements. Regardless of outcome, claims and litigation can adversely affect us due to defense costs, diversion of management and publicity related to such matters.
It is our policy to accrue for amounts related to legal matters if it is probable that a liability has been incurred and anthe amount isof the liability can be reasonably estimable.estimated. Many of the various legal proceedings are covered in whole, or in part, by insurance. Any receivable for insurance recoveries is recorded separate from the corresponding litigation reserve, and only if recovery is determined to be probable. Receivables for insurance recoveries at January 31, 2005 were immaterial.
12. -12-
13. | Segment Information |
Information concerning our operations by reportable operating segment is as follows:
(in 000s)
(in 000s) | ||||||||||||||||||||||||||||||||
Three months ended January 31, | Nine months ended January 31, | |||||||||||||||||||||||||||||||
Three months ended October 31, | Six months ended October 31, | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||||||
Tax Services | $ | 74,106 | $ | 66,284 | $ | 124,553 | $ | 112,265 | $ | 531,086 | $ | 474,495 | $ | 655,639 | $ | 586,760 | ||||||||||||||||
Mortgage Services | 281,634 | 340,173 | 549,767 | 632,762 | 304,643 | 317,599 | 854,410 | 950,361 | ||||||||||||||||||||||||
Business Services | 129,047 | 109,024 | 238,149 | 207,523 | 132,872 | 112,293 | 371,021 | 319,816 | ||||||||||||||||||||||||
Investment Services | 53,761 | 52,703 | 107,342 | 109,690 | 62,104 | 57,753 | 169,446 | 167,443 | ||||||||||||||||||||||||
Corporate | 707 | 688 | 2,155 | 2,016 | 1,302 | 690 | 3,457 | 2,706 | ||||||||||||||||||||||||
$ | 539,255 | $ | 568,872 | $ | 1,021,966 | $ | 1,064,256 | $ | 1,032,007 | $ | 962,830 | $ | 2,053,973 | $ | 2,027,086 | |||||||||||||||||
Pretax income (loss): | ||||||||||||||||||||||||||||||||
Tax Services | $ | (133,972 | ) | $ | (130,383 | ) | $ | (246,961 | ) | $ | (229,963 | ) | $ | 64,337 | $ | 61,827 | $ | (182,624 | ) | $ | (168,136 | ) | ||||||||||
Mortgage Services | 106,200 | 184,026 | 199,740 | 347,855 | 111,681 | 154,476 | 311,421 | 502,331 | ||||||||||||||||||||||||
Business Services | (4,913 | ) | (2,732 | ) | (14,984 | ) | (9,411 | ) | 5,936 | 1,955 | (9,048 | ) | (7,456 | ) | ||||||||||||||||||
Investment Services | (24,566 | ) | (15,336 | ) | (42,837 | ) | (29,093 | ) | (18,312 | ) | (12,811 | ) | (61,149 | ) | (41,904 | ) | ||||||||||||||||
Corporate | (28,673 | ) | (18,441 | ) | (53,446 | ) | (43,425 | ) | (11,959 | ) | (29,327 | ) | (65,405 | ) | (72,752 | ) | ||||||||||||||||
Income (loss) before taxes | $ | (85,924 | ) | $ | 17,134 | $ | (158,488 | ) | $ | 35,963 | $ | 151,683 | $ | 176,120 | $ | (6,805 | ) | $ | 212,083 | |||||||||||||
Our international operations contributed $22.3$12.5 million and $28.1$40.6 million in revenues for the three and sixnine months ended OctoberJanuary 31, 2004,2005, respectively, and $1.2$8.3 million of pretax income and $6.6$14.7 million
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in pretax losses, respectively. Our international operations contributed $19.1$10.8 million and $24.6$35.4 million in revenues for the three and sixnine months ended OctoberJanuary 31, 2003,2004, respectively, and $0.6$6.4 million of pretax income and $5.9$12.3 million in pretax losses, 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 restated to reflect this change.
13. The pretax loss from our Corporate segment for the three and nine months ended January 31, 2005 includes a non-operating gain of $16.7 million, or $0.06 per diluted share, resulting from a legal recovery.
14. | New Accounting Pronouncements |
In December 2004, Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (SFAS 123R) was issued. SFAS 123R revises the original SFAS 123 on stock-based compensation primarily by requiring 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 are effective as of the beginning of our second quarter of fiscal year 2006. We are currently evaluating what effect the adoption of SFAS 123R will have on our consolidated financial statements.
In October 2004, the American Jobs Creation Act (the Act) was signed into law. The Act introduces a one-time deduction for dividends received from the repatriation of certain foreign earnings, provided certain criteria are met. We have begun our evaluation of the effects of the Act, but do not expect to be able to complete this evaluation until additional clarifying language on key elements of the Act are issued. As of January 31, 2005, we have not provided deferred taxes on foreign earnings because we intended to indefinitely reinvest such earnings outside the United States. Whether we will ultimately take advantage of this provision depends on our review of the Act and any additional guidance provided and we are therefore currently uncertain as to the impact, if any, this matter will have on our consolidated financial statements, and are unable to estimate the amount of earnings we may repatriate.
Exposure Draft – Amendment of SFAS 140
The Financial Accounting Standards Board (FASB) intends to reissue the exposure draft, “Qualifying Special Purpose Entities and Isolation of Transferred Assets, an Amendment of FASB Statement No. 140,” during the secondthird quarter of calendar year 2005. The purpose of the proposal is to provide more specific guidance on the accounting for transfers of financial assets to a qualifying special purpose entity (QSPE).QSPE.
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Provisions in the first exposure draft, as well as tentative decisions reached by the FASB during its deliberations, may require us to consolidate our current QSPEs (the Trusts) established in our Mortgage Services segment. As of OctoberJanuary 31, 2004,2005, the Trusts had both assets and liabilities of $3.8$5.3 billion. The provisions of the exposure draft are subject to FASB due process and are subject to change. We will continue to monitor the status of the exposure draft, and consider changes, if any, to current structures as a result of the proposed rules.
14.15. Condensed Consolidating Financial Statements
Block Financial Corporation (BFC) is an indirect, wholly owned consolidated subsidiary of the Company. BFC is the Issuer and the Company is the Guarantor of the Senior Notes issued on October 21, 1997, April 13, 2000 and October 26, 2004. These condensed consolidating financial statements have been prepared using the equity method of accounting. Earnings of subsidiaries are, therefore, reflected in the Company’s investment in subsidiaries account. The elimination entries eliminate investments in subsidiaries, related stockholder’s equity and other intercompany balances and transactions. The income statement for the three and sixnine months ended OctoberJanuary 31, 20032004 and statement of cash flows for the sixnine months ended OctoberJanuary 31, 20032004 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.
Condensed Consolidating Income Statements
(in 000s)
(in 000s) | ||||||||||||||||||||||||||||||||||||||||
Three months ended October 31, 2004 | Three months ended January 31, 2005 | |||||||||||||||||||||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | (Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | |||||||||||||||||||||||||||||||
Total revenues | $ | — | $ | 338,168 | $ | 204,439 | $ | (3,352 | ) | $ | 539,255 | $ | — | $ | 442,279 | $ | 593,396 | $ | (3,668 | ) | $ | 1,032,007 | ||||||||||||||||||
Cost of services | — | 93,834 | 224,936 | 63 | 318,833 | — | 104,532 | 404,641 | (69 | ) | 509,104 | |||||||||||||||||||||||||||||
Other | — | 181,107 | 130,164 | (3,415 | ) | 307,856 | — | 218,724 | 175,827 | (3,599 | ) | 390,952 | ||||||||||||||||||||||||||||
Total expenses | — | 274,941 | 355,100 | (3,352 | ) | 626,689 | — | 323,256 | 580,468 | (3,668 | ) | 900,056 | ||||||||||||||||||||||||||||
Operating income (loss) | — | 63,227 | (150,661 | ) | — | (87,434 | ) | |||||||||||||||||||||||||||||||||
Operating income | — | 119,023 | 12,928 | — | 131,951 | |||||||||||||||||||||||||||||||||||
Other income, net | (85,924 | ) | — | 1,510 | 85,924 | 1,510 | 151,683 | 16,694 | 3,038 | (151,683 | ) | 19,732 | ||||||||||||||||||||||||||||
Income (loss) before taxes | (85,924 | ) | 63,227 | (149,151 | ) | 85,924 | (85,924 | ) | ||||||||||||||||||||||||||||||||
Income taxes (benefit) | (33,725 | ) | 27,201 | (60,926 | ) | 33,725 | (33,725 | ) | ||||||||||||||||||||||||||||||||
Income before taxes | 151,683 | 135,717 | 15,966 | (151,683 | ) | 151,683 | ||||||||||||||||||||||||||||||||||
Income taxes | 59,991 | 55,491 | 4,500 | (59,991 | ) | 59,991 | ||||||||||||||||||||||||||||||||||
Net income (loss) | $ | (52,199 | ) | $ | 36,026 | $ | (88,225 | ) | $ | 52,199 | $ | (52,199 | ) | |||||||||||||||||||||||||||
Net income | $ | 91,692 | $ | 80,226 | $ | 11,466 | $ | (91,692 | ) | $ | 91,692 | |||||||||||||||||||||||||||||
Three months ended January 31, 2004 | ||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | ||||||||||||||||
Total revenues | $ | — | $ | 443,546 | $ | 523,660 | $ | (4,376 | ) | $ | 962,830 | |||||||||
Cost of services | — | 96,911 | 357,669 | (238 | ) | 454,342 | ||||||||||||||
Other | — | 200,534 | 137,698 | (4,248 | ) | 333,984 | ||||||||||||||
Total expenses | — | 297,445 | 495,367 | (4,486 | ) | 788,326 | ||||||||||||||
Operating income | — | 146,101 | 28,293 | 110 | 174,504 | |||||||||||||||
Other income, net | 176,120 | — | 1,616 | (176,120 | ) | 1,616 | ||||||||||||||
Income before taxes | 176,120 | 146,101 | 29,909 | (176,010 | ) | 176,120 | ||||||||||||||
Income taxes | 69,394 | 59,261 | 10,089 | (69,350 | ) | 69,394 | ||||||||||||||
Net income | $ | 106,726 | $ | 86,840 | $ | 19,820 | $ | (106,660 | ) | $ | 106,726 | |||||||||
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Three months ended October 31, 2003 | ||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | ||||||||||||||||
Total revenues | $ | — | $ | 396,296 | $ | 175,308 | $ | (2,732 | ) | $ | 568,872 | |||||||||
Cost of services | — | 85,127 | 198,025 | (226 | ) | 282,926 | ||||||||||||||
Other | — | 175,259 | 97,387 | (2,670 | ) | 269,976 | ||||||||||||||
Total expenses | — | 260,386 | 295,412 | (2,896 | ) | 552,902 | ||||||||||||||
Operating income (loss) | — | 135,910 | (120,104 | ) | 164 | 15,970 | ||||||||||||||
Other income, net | 17,134 | — | 1,164 | (17,134 | ) | 1,164 | ||||||||||||||
Income (loss) before taxes | 17,134 | 135,910 | (118,940 | ) | (16,970 | ) | 17,134 | |||||||||||||
Income taxes (benefit) | 6,758 | 55,323 | (48,629 | ) | (6,694 | ) | 6,758 | |||||||||||||
Net income (loss) | $ | 10,376 | $ | 80,587 | $ | (70,311 | ) | $ | (10,276 | ) | $ | 10,376 | ||||||||
Six months ended October 31, 2004 | ||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | ||||||||||||||||
Total revenues | $ | — | $ | 662,930 | $ | 365,655 | $ | (6,619 | ) | $ | 1,021,966 | |||||||||
Cost of services | — | 189,277 | 418,649 | 109 | 608,035 | |||||||||||||||
Other | — | 354,472 | 228,193 | (6,728 | ) | 575,937 | ||||||||||||||
Total expenses | — | 543,749 | 646,842 | (6,619 | ) | 1,183,972 | ||||||||||||||
Operating income (loss) | — | 119,181 | (281,187 | ) | — | (162,006 | ) | |||||||||||||
Other income, net | (158,488 | ) | — | 3,518 | 158,488 | 3,518 | ||||||||||||||
Income (loss) before taxes | (158,488 | ) | 119,181 | (277,669 | ) | 158,488 | (158,488 | ) | ||||||||||||
Income taxes (benefit) | (62,206 | ) | 51,560 | (113,766 | ) | 62,206 | (62,206 | ) | ||||||||||||
Net income (loss) | $ | (96,282 | ) | $ | 67,621 | $ | (163,903 | ) | $ | 96,282 | $ | (96,282 | ) | |||||||
Six months ended October 31, 2003 | ||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | ||||||||||||||||
Total revenues | $ | — | $ | 751,321 | $ | 318,151 | $ | (5,216 | ) | $ | 1,064,256 | |||||||||
Cost of services | — | 168,521 | 366,489 | (433 | ) | 534,577 | ||||||||||||||
Other | — | 319,160 | 182,527 | (5,112 | ) | 496,575 | ||||||||||||||
Total expenses | — | 487,681 | 549,016 | (5,545 | ) | 1,031,152 | ||||||||||||||
Operating income (loss) | — | 263,640 | (230,865 | ) | 329 | 33,104 | ||||||||||||||
Other income, net | 35,963 | — | 2,859 | (35,963 | ) | 2,859 | ||||||||||||||
Income (loss) before taxes | 35,963 | 263,640 | (228,006 | ) | (35,634 | ) | 35,963 | |||||||||||||
Income taxes (benefit) | 14,068 | 107,467 | (93,528 | ) | (13,939 | ) | 14,068 | |||||||||||||
Net income (loss) before change in accounting | 21,895 | 156,173 | (134,478 | ) | (21,695 | ) | 21,895 | |||||||||||||
Cumulative effect of change in accounting | (6,359 | ) | — | (6,359 | ) | 6,359 | (6,359 | ) | ||||||||||||
Net income (loss) | $ | 15,536 | $ | 156,173 | $ | (140,837 | ) | $ | (15,336 | ) | $ | 15,536 | ||||||||
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Nine months ended January 31, 2005 | ||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | ||||||||||||||||
Total revenues | $ | — | $ | 1,105,209 | $ | 959,051 | $ | (10,287 | ) | $ | 2,053,973 | |||||||||
Cost of services | — | 293,809 | 831,045 | 40 | 1,124,894 | |||||||||||||||
Other | — | 573,196 | 396,265 | (10,327 | ) | 959,134 | ||||||||||||||
Total expenses | — | 867,005 | 1,227,310 | (10,287 | ) | 2,084,028 | ||||||||||||||
Operating income (loss) | — | 238,204 | (268,259 | ) | — | (30,055 | ) | |||||||||||||
Other income, net | (6,805 | ) | 16,694 | 6,556 | 6,805 | 23,250 | ||||||||||||||
Income (loss) before taxes | (6,805 | ) | 254,898 | (261,703 | ) | 6,805 | (6,805 | ) | ||||||||||||
Income taxes (benefit) | (2,215 | ) | 107,051 | (109,266 | ) | 2,215 | (2,215 | ) | ||||||||||||
Net income (loss) | $ | (4,590 | ) | $ | 147,847 | $ | (152,437 | ) | $ | 4,590 | $ | (4,590 | ) | |||||||
Nine months ended January 31, 2004 | ||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | ||||||||||||||||
Total revenues | $ | — | $ | 1,194,867 | $ | 841,811 | $ | (9,592 | ) | $ | 2,027,086 | |||||||||
Cost of services | — | 265,432 | 726,826 | (671 | ) | 991,587 | ||||||||||||||
Other | — | 519,694 | 317,557 | (9,360 | ) | 827,891 | ||||||||||||||
Total expenses | — | 785,126 | 1,044,383 | (10,031 | ) | 1,819,478 | ||||||||||||||
Operating income (loss) | — | 409,741 | (202,572 | ) | 439 | 207,608 | ||||||||||||||
Other income, net | 212,083 | — | 4,475 | (212,083 | ) | 4,475 | ||||||||||||||
Income (loss) before taxes | 212,083 | 409,741 | (198,097 | ) | (211,644 | ) | 212,083 | |||||||||||||
Income taxes (benefit) | 83,462 | 166,728 | (83,439 | ) | (83,289 | ) | 83,462 | |||||||||||||
Net income (loss) before change in accounting | 128,621 | 243,013 | (114,658 | ) | (128,355 | ) | 128,621 | |||||||||||||
Cumulative effect of change in accounting | (6,359 | ) | — | (6,359 | ) | 6,359 | (6,359 | ) | ||||||||||||
Net income (loss) | $ | 122,262 | $ | 243,013 | $ | (121,017 | ) | $ | (121,996 | ) | $ | 122,262 | ||||||||
Condensed Consolidating Balance Sheets
(in 000s)
October 31, 2004 | ||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | ||||||||||||||||
Cash & cash equivalents | $ | — | $ | 175,689 | $ | 400,107 | $ | — | $ | 575,796 | ||||||||||
Cash & cash equivalents- restricted | — | 477,611 | 19,187 | — | 496,798 | |||||||||||||||
Receivables from customers, brokers and dealers, net | — | 610,039 | — | — | 610,039 | |||||||||||||||
Receivables, net | 1,255 | 186,354 | 180,463 | — | 368,072 | |||||||||||||||
Intangible assets and goodwill, net | — | 447,141 | 817,258 | — | 1,264,399 | |||||||||||||||
Investments in subsidiaries | 4,242,076 | 210 | 416 | (4,242,076 | ) | 626 | ||||||||||||||
Other assets | — | 1,178,149 | 402,979 | — | 1,581,128 | |||||||||||||||
Total assets | $ | 4,243,331 | $ | 3,075,193 | $ | 1,820,410 | $ | (4,242,076 | ) | $ | 4,896,858 | |||||||||
Commercial paper | $ | — | $ | 316,056 | $ | — | $ | — | $ | 316,056 | ||||||||||
Accts. payable to customers, brokers and dealers | — | 1,000,083 | — | — | 1,000,083 | |||||||||||||||
Long-term debt | — | 896,173 | 35,608 | — | 931,781 | |||||||||||||||
Other liabilities | 2 | 579,333 | 754,923 | 13 | 1,334,271 | |||||||||||||||
Net intercompany advances | 2,928,662 | (1,084,503 | ) | (1,844,146 | ) | (13 | ) | — | ||||||||||||
Stockholders’ equity | 1,314,667 | 1,368,051 | 2,874,025 | (4,242,076 | ) | 1,314,667 | ||||||||||||||
Total liabilities and stockholders’ equity | $ | 4,243,331 | $ | 3,075,193 | $ | 1,820,410 | $ | (4,242,076 | ) | $ | 4,896,858 | |||||||||
�� | ||||||||||||||||||||||||||||||||||||||||
(in 000s) | ||||||||||||||||||||||||||||||||||||||||
April 30, 2004 | January 31, 2005 | |||||||||||||||||||||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | (Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | |||||||||||||||||||||||||||||||
Cash & cash equivalents | $ | — | $ | 132,076 | $ | 939,600 | $ | — | $ | 1,071,676 | $ | — | $ | 138,602 | $ | 437,544 | $ | — | $ | 576,146 | ||||||||||||||||||||
Cash & cash equivalents- restricted | — | 532,201 | 13,227 | — | 545,428 | |||||||||||||||||||||||||||||||||||
Cash & cash equivalents – restricted | — | 520,000 | 15,318 | — | 535,318 | |||||||||||||||||||||||||||||||||||
Receivables from customers, brokers and dealers, net | — | 625,076 | — | — | 625,076 | — | 623,225 | — | — | 623,225 | ||||||||||||||||||||||||||||||
Receivables, net | 180 | 168,879 | 178,851 | — | 347,910 | 396 | 1,104,735 | 355,966 | — | 1,461,097 | ||||||||||||||||||||||||||||||
Intangible assets and goodwill, net | — | 461,791 | 823,456 | — | 1,285,247 | — | 439,816 | 831,294 | — | 1,271,110 | ||||||||||||||||||||||||||||||
Investments in subsidiaries | 4,291,693 | 205 | 297 | (4,291,693 | ) | 502 | 4,335,074 | 210 | 428 | (4,335,074 | ) | 638 | ||||||||||||||||||||||||||||
Other assets | (145 | ) | 1,115,435 | 389,270 | (373 | ) | 1,504,187 | — | 1,196,549 | 476,989 | 49 | 1,673,587 | ||||||||||||||||||||||||||||
Total assets | $ | 4,291,728 | $ | 3,035,663 | $ | 2,344,701 | $ | (4,292,066 | ) | $ | 5,380,026 | $ | 4,335,470 | $ | 4,023,137 | $ | 2,117,539 | $ | (4,335,025 | ) | $ | 6,141,121 | ||||||||||||||||||
Commercial paper | $ | — | $ | 1,508,784 | $ | 20,098 | $ | — | $ | 1,528,882 | ||||||||||||||||||||||||||||||
Accts. payable to customers, brokers and dealers | $ | — | $ | 1,065,793 | $ | — | $ | — | $ | 1,065,793 | — | 1,035,228 | — | — | 1,035,228 | |||||||||||||||||||||||||
Long-term debt | — | 498,225 | 47,586 | — | 545,811 | — | 896,382 | 32,147 | — | 928,529 | ||||||||||||||||||||||||||||||
Other liabilities | 15,879 | 509,151 | 1,345,822 | 561 | 1,871,413 | 2 | 335,161 | 864,661 | 8 | 1,199,832 | ||||||||||||||||||||||||||||||
Net intercompany advances | 2,378,840 | (304,432 | ) | (2,073,847 | ) | (561 | ) | — | 2,886,818 | (1,196,776 | ) | (1,690,083 | ) | 41 | — | |||||||||||||||||||||||||
Stockholders’ equity | 1,897,009 | 1,266,926 | 3,025,140 | (4,292,066 | ) | 1,897,009 | 1,448,650 | 1,444,358 | 2,890,716 | (4,335,074 | ) | 1,448,650 | ||||||||||||||||||||||||||||
Total liabilities and stockholders’ equity | $ | 4,291,728 | $ | 3,035,663 | $ | 2,344,701 | $ | (4,292,066 | ) | $ | 5,380,026 | $ | 4,335,470 | $ | 4,023,137 | $ | 2,117,539 | $ | (4,335,025 | ) | $ | 6,141,121 | ||||||||||||||||||
-15-
April 30, 2004 | ||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | ||||||||||||||||
Cash & cash equivalents | $ | — | $ | 132,076 | $ | 939,600 | $ | — | $ | 1,071,676 | ||||||||||
Cash & cash equivalents – restricted | — | 532,201 | 13,227 | — | 545,428 | |||||||||||||||
Receivables from customers, brokers and dealers, net | — | 625,076 | — | — | 625,076 | |||||||||||||||
Receivables, net | 180 | 168,879 | 178,851 | — | 347,910 | |||||||||||||||
Intangible assets and goodwill, net | — | 461,791 | 823,456 | — | 1,285,247 | |||||||||||||||
Investments in subsidiaries | 4,291,693 | 205 | 297 | (4,291,693 | ) | 502 | ||||||||||||||
Other assets | (145 | ) | 1,115,435 | 389,270 | (373 | ) | 1,504,187 | |||||||||||||
Total assets | $ | 4,291,728 | $ | 3,035,663 | $ | 2,344,701 | $ | (4,292,066 | ) | $ | 5,380,026 | |||||||||
Accts. 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 | 509,151 | 1,345,822 | 561 | 1,871,413 | |||||||||||||||
Net intercompany advances | 2,378,840 | (304,432 | ) | (2,073,847 | ) | (561 | ) | — | ||||||||||||
Stockholders’ equity | 1,897,009 | 1,266,926 | 3,025,140 | (4,292,066 | ) | 1,897,009 | ||||||||||||||
Total liabilities and stockholders’ equity | $ | 4,291,728 | $ | 3,035,663 | $ | 2,344,701 | $ | (4,292,066 | ) | $ | 5,380,026 | |||||||||
Condensed Consolidating Statements of Cash Flows
(in 000s)
Six months ended October 31, 2004 | ||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | ||||||||||||||||
Net cash used in operating activities: | $ | 810 | $ | 51,811 | $ | (727,708 | ) | $ | — | $ | (675,087 | ) | ||||||||
Cash flows from investing: | ||||||||||||||||||||
Cash received on residuals | — | 73,477 | — | — | 73,477 | |||||||||||||||
Purchase property & equipment | — | (12,785 | ) | (42,464 | ) | — | (55,249 | ) | ||||||||||||
Payments for business acquisitions | — | — | (5,472 | ) | — | (5,472 | ) | |||||||||||||
Net intercompany advances | 544,812 | — | — | (544,812 | ) | — | ||||||||||||||
Other, net | — | (96 | ) | 12,234 | — | 12,138 | ||||||||||||||
Net cash provided by (used in) investing activities | 544,812 | 60,596 | (35,702 | ) | (544,812 | ) | 24,894 | |||||||||||||
Cash flows from financing: | ||||||||||||||||||||
Repayments of commercial paper | — | (1,376,877 | ) | — | — | (1,376,877 | ) | |||||||||||||
Proceeds from commercial paper | — | 1,692,933 | — | — | 1,692,933 | |||||||||||||||
Proceeds from long-term debt | — | 395,221 | — | — | 395,221 | |||||||||||||||
Dividends paid | (69,997 | ) | — | — | — | (69,997 | ) | |||||||||||||
Acquisition of treasury shares | (529,558 | ) | — | — | — | (529,558 | ) | |||||||||||||
Proceeds from common stock | 53,933 | — | — | — | 53,933 | |||||||||||||||
Net intercompany advances | — | (780,071 | ) | 235,259 | 544,812 | — | ||||||||||||||
Other, net | — | — | (11,342 | ) | — | (11,342 | ) | |||||||||||||
Net cash provided by (used in) financing activities | (545,622 | ) | (68,794 | ) | 223,917 | 544,812 | 154,313 | |||||||||||||
Net increase (decrease) in cash | — | 43,613 | (539,493 | ) | — | (495,880 | ) | |||||||||||||
Cash - beginning of period | — | 132,076 | 939,600 | — | 1,071,676 | |||||||||||||||
Cash - end of period | $ | — | $ | 175,689 | $ | 400,107 | $ | — | $ | 575,796 | ||||||||||
(in 000s) | ||||||||||||||||||||||||||||||||||||||||
Six months ended October 31, 2003 | Nine months ended January 31, 2005 | |||||||||||||||||||||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | (Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | |||||||||||||||||||||||||||||||
Net cash provided by (used in) operating activities: | $ | 6,269 | $ | (96,440 | ) | $ | (373,179 | ) | $ | — | $ | (463,350 | ) | $ | 16,683 | $ | (828,974 | ) | $ | (772,960 | ) | $ | — | $ | (1,585,251 | ) | ||||||||||||||
Cash flows from investing: | ||||||||||||||||||||||||||||||||||||||||
Cash received on residuals | — | 68,850 | — | — | 68,850 | — | 100,344 | — | — | 100,344 | ||||||||||||||||||||||||||||||
Purchase property & equipment | — | (10,212 | ) | (33,379 | ) | — | (43,591 | ) | — | (26,355 | ) | (111,128 | ) | — | (137,483 | ) | ||||||||||||||||||||||||
Payments for business acquisitions | — | — | (123,337 | ) | — | (123,337 | ) | — | — | (26,348 | ) | — | (26,348 | ) | ||||||||||||||||||||||||||
Net intercompany advances | 180,814 | — | — | (180,814 | ) | — | 499,699 | — | — | (499,699 | ) | — | ||||||||||||||||||||||||||||
Other, net | — | 16,700 | (10,009 | ) | — | 6,691 | — | (150 | ) | 15,357 | — | 15,207 | ||||||||||||||||||||||||||||
Net cash provided by (used in) investing activities | 180,814 | 75,338 | (166,725 | ) | (180,814 | ) | (91,387 | ) | 499,699 | 73,839 | (122,119 | ) | (499,699 | ) | (48,280 | ) | ||||||||||||||||||||||||
Cash flows from financing: | ||||||||||||||||||||||||||||||||||||||||
Repayments of commercial paper | — | (499,771 | ) | — | — | (499,771 | ) | — | (2,348,966 | ) | — | — | (2,348,966 | ) | ||||||||||||||||||||||||||
Proceeds from commercial paper | — | 624,401 | — | — | 624,401 | — | 3,857,750 | 20,098 | — | 3,877,848 | ||||||||||||||||||||||||||||||
Repayment of long-term debt | — | (250,000 | ) | — | — | (250,000 | ) | |||||||||||||||||||||||||||||||||
Proceeds from long-term debt | — | 395,221 | — | — | 395,221 | |||||||||||||||||||||||||||||||||||
Payments on acquisition debt | — | — | (19,462 | ) | — | (19,462 | ) | |||||||||||||||||||||||||||||||||
Dividends paid | (68,087 | ) | — | — | — | (68,087 | ) | (106,422 | ) | — | — | — | (106,422 | ) | ||||||||||||||||||||||||||
Acquisition of treasury shares | (178,847 | ) | — | — | — | (178,847 | ) | (529,852 | ) | — | — | — | (529,852 | ) | ||||||||||||||||||||||||||
Proceeds from issuance of common stock | 59,851 | — | — | — | 59,851 | |||||||||||||||||||||||||||||||||||
Proceeds from common stock | 119,892 | — | — | — | 119,892 | |||||||||||||||||||||||||||||||||||
Net intercompany advances | — | (175,150 | ) | (5,664 | ) | 180,814 | — | — | (892,344 | ) | 392,645 | 499,699 | — | |||||||||||||||||||||||||||
Other, net | — | 50,100 | (46,933 | ) | — | 3,167 | — | — | (258 | ) | — | (258 | ) | |||||||||||||||||||||||||||
Net cash used in financing activities | (187,083 | ) | (420 | ) | (52,597 | ) | 180,814 | (59,286 | ) | |||||||||||||||||||||||||||||||
Net cash provided by (used in) financing activities | (516,382 | ) | 761,661 | 393,023 | 499,699 | 1,138,001 | ||||||||||||||||||||||||||||||||||
Net decrease in cash | — | (21,522 | ) | (592,501 | ) | — | (614,023 | ) | ||||||||||||||||||||||||||||||||
Cash - beginning of period | — | 180,181 | 695,172 | — | 875,353 | |||||||||||||||||||||||||||||||||||
Net increase (decrease) in cash | — | 6,526 | (502,056 | ) | — | (495,530 | ) | |||||||||||||||||||||||||||||||||
Cash – beginning of period | — | 132,076 | 939,600 | — | 1,071,676 | |||||||||||||||||||||||||||||||||||
Cash - end of period | $ | — | $ | 158,659 | $ | 102,671 | $ | — | $ | 261,330 | ||||||||||||||||||||||||||||||
Cash – end of period | $ | — | $ | 138,602 | $ | 437,544 | $ | — | $ | 576,146 | ||||||||||||||||||||||||||||||
-16-
Nine months ended January 31, 2004 | ||||||||||||||||||||
H&R Block, Inc. | BFC | Other | Consolidated | |||||||||||||||||
(Guarantor) | (Issuer) | Subsidiaries | Elims | H&R Block | ||||||||||||||||
Net cash provided by (used in) operating activities: | $ | 30,336 | $ | (635,888 | ) | $ | (396,088 | ) | $ | — | $ | (1,001,640 | ) | |||||||
Cash flows from investing: | ||||||||||||||||||||
Cash received on residuals | — | 127,997 | — | — | 127,997 | |||||||||||||||
Purchase property & equipment | — | (28,037 | ) | (53,141 | ) | — | (81,178 | ) | ||||||||||||
Payments for business acquisitions | — | — | (280,280 | ) | — | (280,280 | ) | |||||||||||||
Net intercompany advances | 333,289 | — | — | (333,289 | ) | — | ||||||||||||||
Other, net | — | 40,474 | (4,422 | ) | — | 36,052 | ||||||||||||||
Net cash provided by (used in) investing activities | 333,289 | 140,434 | (337,843 | ) | (333,289 | ) | (197,409 | ) | ||||||||||||
Cash flows from financing: | ||||||||||||||||||||
Repayments of commercial paper | — | (1,022,716 | ) | — | — | (1,022,716 | ) | |||||||||||||
Proceeds from commercial paper | — | 2,433,893 | — | — | 2,433,893 | |||||||||||||||
Payments on acquisition debt | — | — | (50,820 | ) | — | (50,820 | ) | |||||||||||||
Repayments of securitization financing | — | (50,100 | ) | — | — | (50,100 | ) | |||||||||||||
Proceeds from securitization financing | — | 50,100 | — | — | 50,100 | |||||||||||||||
Dividends paid | (103,538 | ) | — | — | — | (103,538 | ) | |||||||||||||
Acquisition of treasury shares | (371,242 | ) | — | — | — | (371,242 | ) | |||||||||||||
Proceeds from issuance of common stock | 111,155 | — | — | — | 111,155 | |||||||||||||||
Net intercompany advances | — | (938,167 | ) | 604,878 | 333,289 | — | ||||||||||||||
Other, net | — | — | (1,947 | ) | — | (1,947 | ) | |||||||||||||
Net cash provided by (used in) financing activities | (363,625 | ) | 473,010 | 552,111 | 333,289 | 994,785 | ||||||||||||||
Net decrease in cash | — | (22,444 | ) | (181,820 | ) | — | (204,264 | ) | ||||||||||||
Cash – beginning of period | — | 180,181 | 695,172 | — | 875,353 | |||||||||||||||
Cash – end of period | $ | — | $ | 157,737 | $ | 513,352 | $ | — | $ | 671,089 | ||||||||||
-17-
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
H&R Block is a diversified company delivering tax services and financial advice, investment and mortgage services, and business and consulting services. For nearly 50 years, we have been developing relationships with millions of tax clients and our strategy is to expand on these relationships. Our Tax Services segment provides income tax return preparation services, electronic filing services and other services and products related to income tax return preparation to the general public in the United States, Canada, Australia and the United Kingdom. We also offer investment services through H&R Block Financial Advisors, Inc. (HRBFA). Our Mortgage Services segment offers a full range of home mortgage services through Option One Mortgage Corporation (OOMC) and H&R Block Mortgage Corporation (HRBMC). RSM McGladrey Business Services, Inc. (RSM) is a national accounting, tax and consulting firm primarily serving mid-sized businesses.
Our Mission
To help our clients achieve their financial objectives
by serving as their tax and financial partner.
Key to achieving our mission is the enhancement of client experiences through consistent delivery of valuable services and advice. Operating through multiple lines of business allows us to better meet the changing financial needs of our clients.
The analysis that follows should be read in conjunction with the tables below and the condensed consolidated income statements found on page 2.
Consolidated H&R Block, Inc. – Operating Results | (in 000s, except per share amounts) | |||||||||||||||
Three months ended January 31, | Nine months ended January 31, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Revenues: | ||||||||||||||||
Tax Services | $ | 531,086 | $ | 474,495 | $ | 655,639 | $ | 586,760 | ||||||||
Mortgage Services | 304,643 | 317,599 | 854,410 | 950,361 | ||||||||||||
Business Services | 132,872 | 112,293 | 371,021 | 319,816 | ||||||||||||
Investment Services | 62,104 | 57,753 | 169,446 | 167,443 | ||||||||||||
Corporate | 1,302 | 690 | 3,457 | 2,706 | ||||||||||||
$ | 1,032,007 | $ | 962,830 | $ | 2,053,973 | $ | 2,027,086 | |||||||||
Pretax income (loss): | ||||||||||||||||
Tax Services | $ | 64,337 | $ | 61,827 | $ | (182,624 | ) | $ | (168,136 | ) | ||||||
Mortgage Services | 111,681 | 154,476 | 311,421 | 502,331 | ||||||||||||
Business Services | 5,936 | 1,955 | (9,048 | ) | (7,456 | ) | ||||||||||
Investment Services | (18,312 | ) | (12,811 | ) | (61,149 | ) | (41,904 | ) | ||||||||
Corporate | (11,959 | ) | (29,327 | ) | (65,405 | ) | (72,752 | ) | ||||||||
151,683 | 176,120 | (6,805 | ) | 212,083 | ||||||||||||
Income taxes (benefit) | 59,991 | 69,394 | (2,215 | ) | 83,462 | |||||||||||
Net income (loss) before change in accounting principle | 91,692 | 106,726 | (4,590 | ) | 128,621 | |||||||||||
Cumulative effect of change in accounting principle | — | — | — | (6,359 | ) | |||||||||||
Net income (loss) | $ | 91,692 | $ | 106,726 | $ | (4,590 | ) | $ | 122,262 | |||||||
Basic earnings (loss) per share | $ | .56 | $ | .60 | $ | (.03 | ) | $ | .69 | |||||||
Diluted earnings (loss) per share | $ | .55 | $ | .59 | $ | (.03 | ) | $ | .67 | |||||||
Three months ended October 31, | Six months ended October 31, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
Revenues: | ||||||||||||||||
Tax Services | $ | 74,106 | $ | 66,284 | $ | 124,553 | $ | 112,265 | ||||||||
Mortgage Services | 281,634 | 340,173 | 549,767 | 632,762 | ||||||||||||
Business Services | 129,047 | 109,024 | 238,149 | 207,523 | ||||||||||||
Investment Services | 53,761 | 52,703 | 107,342 | 109,690 | ||||||||||||
Corporate | 707 | 688 | 2,155 | 2,016 | ||||||||||||
$ | 539,255 | $ | 568,872 | $ | 1,021,966 | $ | 1,064,256 | |||||||||
Pretax income (loss): | ||||||||||||||||
Tax Services | $ | (133,972 | ) | $ | (130,383 | ) | $ | (246,961 | ) | $ | (229,963 | ) | ||||
Mortgage Services | 106,200 | 184,026 | 199,740 | 347,855 | ||||||||||||
Business Services | (4,913 | ) | (2,732 | ) | (14,984 | ) | (9,411 | ) | ||||||||
Investment Services | (24,566 | ) | (15,336 | ) | (42,837 | ) | (29,093 | ) | ||||||||
Corporate | (28,673 | ) | (18,441 | ) | (53,446 | ) | (43,425 | ) | ||||||||
Income (loss) before taxes | (85,924 | ) | 17,134 | (158,488 | ) | 35,963 | ||||||||||
Income taxes (benefit) | (33,725 | ) | 6,758 | (62,206 | ) | 14,068 | ||||||||||
Net income (loss) before change in accounting principle | (52,199 | ) | 10,376 | (96,282 | ) | 21,895 | ||||||||||
Cumulative effect of change in accounting principle | — | — | — | (6,359 | ) | |||||||||||
Net income (loss) | $ | (52,199 | ) | $ | 10,376 | $ | (96,282 | ) | $ | 15,536 | ||||||
Basic earnings (loss) per share | $ | (.32 | ) | $ | .06 | $ | (.58 | ) | $ | .09 | ||||||
Diluted earnings (loss) per share | $ | (.32 | ) | $ | .06 | $ | (.58 | ) | $ | .09 | ||||||
OVERVIEW
A summary of our results for the six months ended October 31, 2004 compared to the prior year is as follows:
• | Diluted earnings per share for the three months ended January 31, 2005 and 2004 was $0.55 and $0.59, respectively, and a loss of $0.03 and income of $0.67 for the respective nine-month periods. Results for the current quarter include a non-operating gain of $16.7 million, or $0.06 per diluted share, resulting from a legal recovery. |
-17--18-
• | Tax Services’ pretax income increased $2.5 million, to $64.3 million for the quarter. For the nine months, the pretax loss increased | |||
• | Mortgage Services’ revenues and pretax | |||
• | Business Services’ revenues increased | |||
• | Investment Services’ revenues |
TAX SERVICES
This segment primarily consists of our income tax preparation businesses – retail, online and software.
Tax Services – Operating Statistics (U.S. only) | ||||||||
Period January 1 through January 31, | ||||||||
2005 | 2004 | |||||||
Clients served (in 000s): | ||||||||
Company-owned offices | 2,447 | 2,362 | ||||||
Franchise offices | 1,406 | 1,352 | ||||||
Digital tax solutions(1) | 1,129 | 1,268 | ||||||
4,982 | 4,982 | |||||||
Average fee per client served:(2) | ||||||||
Company-owned offices | $ | 149.94 | $ | 140.25 | ||||
Franchise offices | 130.82 | 125.61 | ||||||
$ | 142.97 | $ | 134.92 | |||||
Refund anticipation loans (RALs) (in 000s): | ||||||||
Company-owned offices | 1,197 | 1,184 | ||||||
Franchise offices | 714 | 709 | ||||||
Digital tax solutions | 12 | 20 | ||||||
1,923 | 1,913 | |||||||
Offices: | ||||||||
Company-owned offices | 5,811 | 5,172 | ||||||
Company-owned shared office locations(3) | 1,296 | 996 | ||||||
Total company-owned offices | 7,107 | 6,168 | ||||||
Franchise offices | 3,528 | 3,418 | ||||||
Franchise shared office locations(3) | 526 | 323 | ||||||
Total franchise offices | 4,054 | 3,741 | ||||||
11,161 | 9,909 | |||||||
(2) Calculated as tax preparation and related fees divided by clients served. | ||
(3) Shared locations include offices located within Wal-Mart, Sears and other third-party businesses. |
-19-
Tax Services – Operating Results | (in 000s) | |||||||||||||||
Three months ended January 31, | Nine months ended January 31, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Service revenues: | ||||||||||||||||
Tax preparation and related fees | $ | 375,343 | $ | 339,204 | $ | 428,322 | $ | 383,993 | ||||||||
Online tax services | 10,740 | 8,200 | 12,048 | 9,171 | ||||||||||||
Other services | 23,885 | 15,812 | 77,025 | 64,771 | ||||||||||||
409,968 | 363,216 | 517,395 | 457,935 | |||||||||||||
Royalties | 50,920 | 44,427 | 56,271 | 49,410 | ||||||||||||
RAL participation fees | 43,354 | 37,185 | 43,520 | 37,192 | ||||||||||||
RAL waiver fees | — | 988 | — | 6,548 | ||||||||||||
Software sales | 17,812 | 18,915 | 20,437 | 19,733 | ||||||||||||
Other | 9,032 | 9,764 | 18,016 | 15,942 | ||||||||||||
Total revenues | 531,086 | 474,495 | 655,639 | 586,760 | ||||||||||||
Cost of services: | ||||||||||||||||
Compensation and benefits | 179,187 | 160,001 | 253,108 | 226,240 | ||||||||||||
Occupancy | 74,270 | 66,142 | 177,779 | 158,444 | ||||||||||||
Depreciation | 14,907 | 12,924 | 33,522 | 31,021 | ||||||||||||
Supplies | 12,701 | 11,410 | 20,716 | 17,897 | ||||||||||||
Other | 47,484 | 42,872 | 106,860 | 101,808 | ||||||||||||
328,549 | 293,349 | 591,985 | 535,410 | |||||||||||||
Cost of software sales | 12,731 | 13,231 | 20,400 | 19,939 | ||||||||||||
Selling, general and administrative | 125,469 | 106,088 | 225,878 | 199,547 | ||||||||||||
Total expenses | 466,749 | 412,668 | 838,263 | 754,896 | ||||||||||||
Pretax income (loss) | $ | 64,337 | $ | 61,827 | $ | (182,624 | ) | $ | (168,136 | ) | ||||||
Three months ended October 31, | Six months ended October 31, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
Service revenues: | ||||||||||||||||
Tax preparation and related fees | $ | 33,986 | $ | 28,770 | $ | 53,148 | $ | 45,018 | ||||||||
Online tax services | 607 | 424 | 1,308 | 971 | ||||||||||||
Other services | 28,714 | 27,269 | 52,971 | 48,730 | ||||||||||||
63,307 | 56,463 | 107,427 | 94,719 | |||||||||||||
Software sales | 1,280 | 701 | 2,625 | 818 | ||||||||||||
Royalties | 3,739 | 3,416 | 5,351 | 4,983 | ||||||||||||
RAL waiver fees | — | 1,446 | — | 5,560 | ||||||||||||
Other | 5,780 | 4,258 | 9,150 | 6,185 | ||||||||||||
Total revenues | 74,106 | 66,284 | 124,553 | 112,265 | ||||||||||||
Cost of services: | ||||||||||||||||
Compensation and benefits | 43,237 | 38,425 | 73,921 | 66,239 | ||||||||||||
Occupancy | 52,838 | 48,299 | 103,509 | 92,302 | ||||||||||||
Depreciation | 9,637 | 9,686 | 18,615 | 18,097 | ||||||||||||
Supplies | 5,754 | 4,873 | 8,015 | 6,487 | ||||||||||||
Other | 31,480 | 32,155 | 59,376 | 58,936 | ||||||||||||
142,946 | 133,438 | 263,436 | 242,061 | |||||||||||||
Cost of software sales | 4,399 | 4,625 | 7,669 | 6,708 | ||||||||||||
Selling, general and administrative | 60,733 | 58,604 | 100,409 | 93,459 | ||||||||||||
Total expenses | 208,078 | 196,667 | 371,514 | 342,228 | ||||||||||||
Pretax loss | $ | (133,972 | ) | $ | (130,383 | ) | $ | (246,961 | ) | $ | (229,963 | ) | ||||
Three months ended OctoberJanuary 31, 20042005 compared to OctoberJanuary 31, 2003
2004
Tax Services’ revenues increased $7.8$56.6 million, or 11.8%11.9%, for the three months ended OctoberJanuary 31, 20042005 compared to the prior year.
Tax preparation and related fees increased $5.2$36.1 million, or 18.1%10.7%, for the current quarter. This increase is primarily due in part to Australian operations, which is currentlyan increase in the middle of its tax season. Australian tax returns preparedaverage fee per U.S. client served, coupled with an increase in U.S. clients served in offices. The average fee per client served increased 7.0% and the average charge increased 2.4%, resulting in $2.7 million of additional revenues. Revenues also increased $1.2 million due6.9% to clients accepting their returns$149.94 in the current quarter, which were started and/or completedyear compared to $140.25 last year. Clients served in a previous fiscalcompany-owned offices during the current tax season totaled 2.4 million, up 3.6% from the prior year. We estimate that approximately $10.8 million of the total increase is due to new offices opened during the current year.
Other service revenues increased $1.4$8.1 million primarily as a result of additional revenues associated with Refund Anticipation Checks (RACs), Express IRAs and, to a lesser extent, increased revenues from POM guarantees.
The average fee per client served at franchise offices increased by 4.1%, while clients served rose 4.0%. These increases, coupled with a slight increase in the royalty rate during the current quarter, resulted in a $6.5 million increase in royalty revenue.
Revenues earned during the current quarter in connection with RAL participations totaled $43.4 million, an increase of 16.6% over the prior year. This increase is primarily due to an increase in the dollar value 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 an increase in the maximum loan amount allowed by the lender.
Cost of services for the three months ended OctoberJanuary 31, 20042005 increased $9.5$35.2 million, or 7.1%12.0%, from the prior year. Our real estate expansion efforts have contributed to increases across all cost of services categories and resulted in both our occupancy expensesa net 639 new stand-alone company-owned offices and costs related to additional tax courses offered, which we anticipate will provide us with
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the staffing necessary for thea net 300 new offices.company-owned shared-office locations. Compensation and benefits increased $4.8$19.2 million primarily due to an increase in the instructorsnumber of tax professionals and support personnelstaff needed to offer these additional tax courses,for our new offices, the increase in revenues and $1.1 million in increased stock-based compensation for seasonal employees. Additionally, off-season expenses related to the former major franchise territories acquired in the second quarter of fiscal year 2004, increased compensation and benefits $1.0 million. These increases were partially offset by a decrease inhigher payroll tax expenses resulting from rate adjustments implemented by certain states.rates. Occupancy expenses increased $4.5$8.1 million, or 12.3%, primarily as a result of a 9.5%higher rent expenses, due to an 11.3% increase in company-owned offices under lease and an 8.2%a 2.7% increase in the average rent. Former major franchise territoriesUtilities related to these new offices also contributed $1.9to the increase. Other cost of service expenses increased $4.6 million of this increase.primarily due to additional expenses associated with our POM program.
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Selling, general and administrative expenses increased $2.1$19.4 million over the prior year primarily due to increased spending of $6.8on marketing initiatives and a $5.1 million primarily related to additional technology projects and marketing efforts for our expanded tax courses. We also saw increases in consulting, travel and intangible amortization expenses. These increases were partially offset by decreasesincrease in legal expenses. Legal expenses and interest accretion relatedincreased partially due to legal settlements.reserves required for RAL-related litigation.
The pretax lossPretax income of $134.0$64.3 million for the three months ended OctoberJanuary 31, 20042005 represents a 2.8%4.1% increase over the prior year lossincome of $130.4$61.8 million.
Due to the seasonal nature of this segment’s business, operating results for the three months ended OctoberJanuary 31, 20042005 are not comparable to the three months ended JulyOctober 31, 2004 and are not indicative of the expected results for the entire fiscal year.
SixNine months ended OctoberJanuary 31, 20042005 compared to OctoberJanuary 31, 20032004
Tax Services’ revenues increased $12.3$68.9 million, or 10.9%11.7%, for the sixnine months ended OctoberJanuary 31, 20042005 compared to the prior year.
Tax preparation and related fees increased $8.1$44.3 million, or 18.1%11.5%, for the sixnine months ended OctoberJanuary 31, 2004.2005. This increase is primarily due to a $3.1 millionan increase related to clients accepting their returns in the current period which were started and/or completedaverage fee per client served, coupled with an increase in a previous fiscal year.U.S. clients served in offices during the first month of the tax season. Australian operations contributed $3.0 million in additional revenues as a result of increases in tax returns prepared of 7.1%increased 5.2% and the average charge increased 2.8%, resulting in $3.6 million of 2.5%. Our former major franchise territories, which are now being operated as company-owned, contributed $2.0 million in additional tax preparation and related fees.revenues.
Other service revenues increased $4.2$12.3 million primarily as a result of additional revenues associated with POM guarantees.guarantees and, to a lesser extent, increased revenues from RACs and Express IRAs.
The average fee per client served and clients served both increased at our franchise offices, resulting in an increase in royalty revenue of 13.9%.
Revenues earned during the current year in connection with RALs declined $5.4RAL participations totaled $43.5 million, as a resultan increase of 17.0% over the prior year. 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. This increase was offset by the elimination of RAL waiver revenue in the prior year associated with the RAL waiver agreement in the prior year.agreement.
Cost of services for the sixnine months ended OctoberJanuary 31, 20042005 were up $21.4$56.6 million, or 8.8%10.6%, from the prior year. Compensation and benefits increased $7.7$26.9 million primarily due to $3.1 million morean increase in off-season expenses incurred related to former major franchise territories acquired in the second quarter of fiscal year 2004. Increased numbers of instructors and support personnel needed to operate the higher number of tax courses offered this year also contributed to the increase. These increases were partially offset by a decrease in payroll tax expenses resulting from rate adjustments implemented by certain states.professionals and support staff needed for our real estate expansion and increased revenues. Occupancy expenses increased $11.2$19.3 million, or 12.2%, as a result of a 9.0%an 11.3% increase in company-owned offices under lease and an 8.3% increase in the average rent. Former major franchise territories contributed $4.8lease. Other cost of service expenses increased $5.1 million of this increase.primarily due to additional expenses associated with Express IRAs.
Selling, general and administrative expenses increased $7.0$26.3 million over the prior year due to increased spending of $10.3 million, primarily as a result ofrelated to additional technology and marketing efforts, undertaken in the current year. We also saw increases in consulting, travel and intangible amortization expenses. These increases were partially offset by decreases in legal expenses and in interest accretion related to legal settlements.information technology expenses.
The pretax loss of $247.0$182.6 million for the sixnine months ended OctoberJanuary 31, 20042005 represents a 7.4%an 8.6% increase over the prior year loss of $230.0$168.1 million.
Fiscal 2005 outlook
Our fiscal year 2005 outlook for the Tax Services segment is unchanged from the discussion in our April 30, 2004 Form 10-K and our JulyOctober 31, 2004 Form 10-Q. WeClients served across our retail network through February 15, 2005 were up 4.0% and we believe we are on targettrack to open between 650 and
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700 stand-alone offices acrossmeet our company-owned and franchise network, and approximately 400 additional Wal-Mart locationsexpectations for the upcoming taxyear. However, results in interim periods may not necessarily be representative of the overall results for the season.
RAL Litigation
We have been named as a defendant in a number of lawsuits alleging that we engaged in wrongdoing with respect to the RAL program. We believe we have strong defenses to the various RAL cases and will vigorously defend our position. Nevertheless, the amounts claimed by the plaintiffs are, in some instances, very substantial, and there can be no assurances as to the ultimate outcome of the pending RAL cases, or as to the impact of the RAL cases on our financial statements. See additional discussion of RAL Litigation in note 1112 to the condensed consolidated financial statements.statements and in Part II, Item 1, “Legal Proceedings.”
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MORTGAGE SERVICES
This segment is primarily engaged in the origination of non-prime mortgage loans through an independent broker network, the origination of prime and non-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) | |||||||||||
Three months ended | January 31, 2005 | January 31, 2004 | October 31, 2004 | |||||||||
Volume of loans originated: | ||||||||||||
Wholesale (non-prime) | $ | 7,378,071 | $ | 4,732,182 | $ | 5,528,361 | ||||||
Retail:Prime | 238,867 | 157,438 | 183,647 | |||||||||
Non-prime | 776,797 | 464,926 | 800,975 | |||||||||
$ | 8,393,735 | $ | 5,354,546 | $ | 6,512,983 | |||||||
Loan characteristics: | ||||||||||||
Weighted average FICO score(1) | 615 | 607 | 609 | |||||||||
Weighted average interest rate for borrowers(1) | 7.30 | % | 7.47 | % | 7.46 | % | ||||||
Weighted average loan-to-value(1) | 79.3 | % | 78.1 | % | 78.3 | % | ||||||
Revenue (loan value): | ||||||||||||
Net gain on sale – gross margin(2) | 2.42 | % | 3.93 | % | 2.83 | % | ||||||
Loan delivery: | ||||||||||||
Loan sales | $ | 8,348,537 | $ | 5,308,800 | $ | 6,560,780 | ||||||
Execution price(3) | 2.82 | % | 4.08 | % | 2.94 | % |
Three months ended | October 31, 2004 | October 31, 2003 | July 31, 2004 | |||||||||
Number of loans originated: | ||||||||||||
Wholesale (non-prime) | 34,385 | 36,233 | 37,487 | |||||||||
Retail: Prime | 1,365 | 1,944 | 1,697 | |||||||||
Non-prime | 5,672 | 4,110 | 4,742 | |||||||||
41,422 | 42,287 | 43,926 | ||||||||||
Volume of loans originated: | ||||||||||||
Wholesale (non-prime) | $ | 5,528,361 | $ | 5,603,118 | $ | 5,981,104 | ||||||
Retail: Prime | 183,647 | 247,661 | 215,287 | |||||||||
Non-prime | 800,975 | 492,977 | 620,126 | |||||||||
$ | 6,512,983 | $ | 6,343,756 | $ | 6,816,517 | |||||||
Loan characteristics: | ||||||||||||
Weighted average FICO score(1) | 609 | 611 | 609 | |||||||||
Weighted average interest rate for borrowers(1) | 7.46% | 7.51% | 7.21% | |||||||||
Weighted average loan-to-value(1) | 78.3% | 78.2% | 78.0% | |||||||||
Revenue (loan value): | ||||||||||||
Net gain on sale – gross margin(2) | 2.83% | 3.96% | 2.72% | |||||||||
Loan delivery: | ||||||||||||
Loan sales | $ | 6,560,780 | $ | 6,330,449 | $ | 6,744,056 | ||||||
Execution price(3) | 2.94% | 3.87% | 4.12% |
(2) | 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. | |
(3)Defined as total premium received divided by total balance of loans delivered to |
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Mortgage Services - Operating Results | Mortgage Services - Operating Results | (in 000s) | |||||||||||||||||||||||
Three months ended | October 31, 2004 | October 31, 2003 | July 31, 2004 | January 31, 2005 | January 31, 2004 | October 31, 2004 | |||||||||||||||||||
Components of gains on sales: | |||||||||||||||||||||||||
Gains on mortgage loans | $ | 184,589 | $ | 250,921 | $ | 185,528 | |||||||||||||||||||
Gain on mortgage loans | $ | 172,381 | $ | 217,915 | $ | 187,195 | |||||||||||||||||||
Gain (loss) on derivatives | 30,756 | (7,724 | ) | (2,606 | ) | ||||||||||||||||||||
Gain on sales of residual interests | — | 17,000 | — | ||||||||||||||||||||||
Impairment of residual interests | (34 | ) | (363 | ) | (3,435 | ) | (4,835 | ) | (14,942 | ) | (34 | ) | |||||||||||||
184,555 | 250,558 | 182,093 | 198,302 | 212,249 | 184,555 | ||||||||||||||||||||
Interest income: | |||||||||||||||||||||||||
Accretion – residual interests | 32,172 | 36,843 | 25,663 | ||||||||||||||||||||||
Accretion - residual interests | 28,782 | 47,483 | 32,172 | ||||||||||||||||||||||
Other interest income | 2,445 | 606 | 1,439 | 4,064 | 2,227 | 2,445 | |||||||||||||||||||
34,617 | 37,449 | 27,102 | 32,846 | 49,710 | 34,617 | ||||||||||||||||||||
Loan servicing revenue | 61,907 | 51,659 | 58,855 | 72,928 | 55,072 | 61,907 | |||||||||||||||||||
Other | 555 | 507 | 83 | 567 | 568 | 555 | |||||||||||||||||||
Total revenues | 281,634 | 340,173 | 268,133 | 304,643 | 317,599 | 281,634 | |||||||||||||||||||
Cost of services | 53,062 | 48,507 | 52,113 | 56,694 | 52,832 | 53,062 | |||||||||||||||||||
Compensation and benefits | 68,945 | 63,614 | 76,157 | 80,185 | 62,874 | 68,945 | |||||||||||||||||||
Occupancy | 11,327 | 9,550 | 9,964 | 11,519 | 9,059 | 11,327 | |||||||||||||||||||
Other | 42,100 | 34,476 | 36,359 | 44,564 | 38,358 | 42,100 | |||||||||||||||||||
Total expenses | 175,434 | 156,147 | 174,593 | 192,962 | 163,123 | 175,434 | |||||||||||||||||||
Pretax income | $ | 106,200 | $ | 184,026 | $ | 93,540 | $ | 111,681 | $ | 154,476 | $ | 106,200 | |||||||||||||
Three months ended OctoberJanuary 31, 20042005 compared to OctoberJanuary 31, 2003
2004
Mortgage Services’ revenues decreased $58.5$13.0 million, or 17.2%4.1%, for the three months ended OctoberJanuary 31, 20042005 compared to the prior year. Revenues decreased as a result of a decline in gains on sales of mortgage loans.loans and residual interests and lower accretion income, somewhat offset by gains on derivatives and increased servicing revenue.
The following table summarizes the key drivers of gains on sales of mortgage loans:
(dollars in 000s)
Three months ended October 31, | 2004 | 2003 | ||||||||||||||
(dollars in 000s) | (dollars in 000s) | |||||||||||||||
Three months ended January 31, | 2005 | 2004 | ||||||||||||||
Application process: | ||||||||||||||||
Total number of applications | 72,699 | 72,858 | 84,810 | 59,328 | ||||||||||||
Number of sales associates(1) | 3,369 | 2,476 | 3,523 | 2,649 | ||||||||||||
Closing ratio(2) | 57.0% | 58.0% | 60.4 | % | 60.3 | % | ||||||||||
Originations: | ||||||||||||||||
Total number of originations | 41,422 | 42,287 | 51,267 | 35,795 | ||||||||||||
Weighted average interest rate for borrowers (WAC) | 7.46% | 7.51% | 7.30 | % | 7.47 | % | ||||||||||
Average loan size | $ | 157 | $ | 150 | $ | 164 | $ | 150 | ||||||||
Total originations | $ | 6,512,983 | $ | 6,343,756 | $ | 8,393,735 | $ | 5,354,546 | ||||||||
Non-prime / prime origination ratio | 34.5 : 1 | 24.6 : 1 | ||||||||||||||
Direct origination expenses, net | $ | 86,239 | $ | 73,776 | ||||||||||||
Non-prime origination ratio | 97.2 | % | 97.1 | % | ||||||||||||
Direct origination and acquisition expenses, net | $ | 110,432 | $ | 75,257 | ||||||||||||
Revenue (loan value): | ||||||||||||||||
Net gain on sale – gross margin(3) | 2.83% | 3.96% | ||||||||||||||
Net gain on sale - gross margin(3) | 2.42 | % | 3.93 | % | ||||||||||||
(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. |
GainsAlthough we continue to grow our origination volumes, up 56.8% over the prior year, gains on sales of mortgage loans declined $66.3$45.5 million, primarily as a result of increased price competition and poorer execution in the secondary market. Market interest rates, based on a two-year swap, increased from 2.19%2.20% last year to 2.94%3.64% at the end of the current quarter, up 74 basis points.quarter. However, our WAC declined fiveto 7.30% from 7.47% in the prior year. Because our WAC was not more aligned with market rates, our gross margin declined 151 basis points, to 2.42% from 3.93% last year. To mitigate the risk of short-term changes in market interest rates, we use interest rate swaps and forward loan sale commitments. During the current
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quarter, we recorded a net $30.8 million in gains, compared to losses of $7.7 million in the prior year, resulting in a decline of 113 basis points inrelated to our gross margin,various derivative instruments. See note 6 to 2.83% from 3.96% last year. Additionally, direct origination expenses increased $12.5 million, primarily due to increases in broker incentives and origination volume.the condensed consolidated financial statements.
During the current quarter,year, we reclassified the accretion on our beneficial interest in Trusts, which includes actual cash received from the Trusts in excess of those estimated, from interest income to gain on sale. This change was made to more accurately reflect the characteristics of the proceeds received by the beneficial interest holders upon disposition of the loans by the Trusts. Amounts reclassified from interest income to gains on sales for the three months ended OctoberJanuary 31, 20032004 totaled $41.3$57.6 million. This change had no impact on our net income as previously reported.
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The following table summarizes the key drivers of loan servicing revenues:
(dollars in 000s)
Three months ended October 31, | 2004 | 2003 | ||||||||||||||
(dollars in 000s) | ||||||||||||||||
Three months ended January 31, | 2005 | 2004 | ||||||||||||||
Average servicing portfolio: | ||||||||||||||||
With related MSRs | $ | 39,407,600 | $ | 30,716,220 | $ | 41,753,865 | $ | 33,427,112 | ||||||||
Without related MSRs | 11,917,124 | 6,108,813 | 15,584,677 | 7,797,396 | ||||||||||||
$ | 51,324,724 | $ | 36,825,033 | $ | 57,338,542 | $ | 41,224,508 | |||||||||
Number of loans serviced | 362,430 | 295,636 | 387,619 | 308,305 | ||||||||||||
Average delinquency rate | 5.19% | 6.28% | 5.02 | % | 6.00 | % | ||||||||||
Value of MSRs | $ | 134,062 | $ | 111,960 | $ | 147,511 | $ | 106,196 | ||||||||
Loan servicing revenues increased $10.2$17.9 million, or 19.8%32.4%, compared to the prior year. The increase reflects a higher loan servicing portfolio. The average servicing portfolio for the three months ended OctoberJanuary 31, 20042005 increased $14.5$16.1 billion, or 39.4%39.1%, to $51.3$57.3 billion.
Accretion of residual interests of $32.2$28.8 million for the three months ended OctoberJanuary 31, 20042005 represents a decrease of $4.7$18.7 million from the prior year. 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 and reduced the balance of residual interests from $317.6 million at October 31, 2003 to $261.5 million at October 31, 2004.interests.
During the secondthird quarter of fiscal year 2005, our residual interests continued to perform better than expected compared to internal valuation models.models, primarily due to credit losses performing better than originally modeled. We recorded favorable pretax mark-to-market adjustments, which increased the fair value of our residual interests $47.1$18.8 million during the quarter. These adjustments were recorded, net of write-downs of $11.7$9.0 million and deferred taxes of $13.5$3.8 million, in other comprehensive income and will be accreted into income throughout the remaining life of those residual interests. 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 the residual interests and could cause changes to the accretion of these residual interests in future periods. Favorable mark-to-market adjustments on low original value residuals will generally not be accreted into revenues until the residual interest begins to cash flow.
Total expenses for the three months ended OctoberJanuary 31, 2004,2005, increased $19.3$29.8 million, or 12.4%18.3%, over the year-ago quarter. This increase is partiallyprimarily due to $5.3$17.3 million in increased compensation and benefits as a result of a 36.1%33.0% increase in sales associates. We did not achieve the level of loan productionassociates, coupled with related increases in our second quarter that we were staffed to support. Occupancy expenses increased as a result of new branch offices opened since October of last year.payroll taxes and origination-based incentives. Other expenses increased $7.6$6.2 million for the current quarter, primarily due to a $3.6$1.5 million increase in consulting expenses.expenses, and similar increases in depreciation and travel. Costs related to servicing of mortgage loans increased $4.6$3.9 million as a result of a higher average servicing portfolio during the three months ended OctoberJanuary 31, 2004.2005.
Pretax income decreased $77.8$42.8 million to $106.2$111.7 million for the three months ended OctoberJanuary 31, 2004.2005.
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Three months ended January 31, 2005 compared to October 31, 2004 compared to July 31, 2004
Mortgage Services’ revenues increased $13.5$23.0 million, or 5.0%8.2%, for the three months ended OctoberJanuary 31, 2004,2005, compared to the firstsecond quarter. RevenueRevenues increased due to gains on derivatives and higher accretionservicing revenues, partially offset by lower gains on residual interests, a decline in impairmentssales of residual interests and increased servicing revenues.mortgage loans.
The following table summarizes the key drivers of gains on sales of mortgage loans:
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(dollars in 000s) | ||||||||
Three months ended | January 31, 2005 | October 31, 2004 | ||||||
Application process: | ||||||||
Total number of applications | 84,810 | 72,699 | ||||||
Number of sales associates(1) | 3,523 | 3,369 | ||||||
Closing ratio(2) | 60.4 | % | 57.0 | % | ||||
Originations: | ||||||||
Total number of originations | 51,267 | 41,422 | ||||||
Weighted average interest rate for borrowers (WAC) | 7.30 | % | 7.46 | % | ||||
Average loan size | $ | 164 | $ | 157 | ||||
Total originations | $ | 8,393,735 | $ | 6,512,983 | ||||
Non-prime origination ratio | 97.2 | % | 97.2 | % | ||||
Direct origination and acquisition expenses, net | $ | 110,432 | $ | 86,239 | ||||
Revenue (loan value): | ||||||||
Net gain on sale - gross margin(3) | 2.42 | % | 2.83 | % | ||||
(dollars in 000s)
Three months ended | October 31, 2004 | July 31, 2004 | ||||||
Application process: | ||||||||
Total number of applications | 72,699 | 74,492 | ||||||
Number of sales associates(1) | 3,369 | 3,117 | ||||||
Closing ratio(2) | 57.0% | 59.0% | ||||||
Originations: | ||||||||
Total number of originations | 41,422 | 43,926 | ||||||
Weighted average interest rate for borrowers | 7.46% | 7.21% | ||||||
Average loan size | $ | 157 | $ | 155 | ||||
Total originations | $ | 6,512,983 | $ | 6,816,517 | ||||
Non-prime / prime origination ratio | 34.5 : 1 | 30.7 : 1 | ||||||
Direct origination expenses, net | $ | 86,239 | $ | 102,878 | ||||
Revenue (loan value): | ||||||||
Net gain on sale – gross margin(3) | 2.83% | 2.72% |
(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. |
Gains on sales of mortgage loans decreased $0.9$14.8 million primarily as a result of lower origination volumes.increased price competition and poorer execution in the secondary market. Market interest rates have increased to 3.64% from 2.94% in the second quarter. However our WAC declined from 7.46% to 7.30%. Because our WAC was not more aligned with market rates, our gross margin declined 41 basis points. To mitigate the risk of short-term changes in market interest rates, we use interest rate swaps and forward loan sale commitments. During the current quarter, we recorded a net $30.8 million in gains, compared to a net loss of $2.6 million in the second quarter, related to our various derivative instruments. Loan origination volumes decreased 4.5%increased 28.9% from the firstsecond quarter primarily due to increased price competition. This decrease was offset by an increase in our gross margin and a $16.6 million decline in direct origination expenses. Market interest rates have decreased nine basis points since the first quarter, however during the quarter, our WAC increased 25 basis points, resulting in an 11 basis point improvement in our gross margin. Amounts reclassified from interest income to gains onhiring of additional sales for the three months ended July 31, 2004 totaled $44.6 million. This change had no impact on our net income as previously reported.associates.
Impairments of residual interests in securitizations of $3.4$4.8 million were recognized during the firstthird quarter.
The following table summarizes the key drivers of loan servicing revenues:
(dollars in 000s)
(dollars in 000s) | ||||||||||||||||
Three months ended | October 31, 2004 | July 31, 2004 | January 31, 2005 | October 31, 2004 | ||||||||||||
Average servicing portfolio: | ||||||||||||||||
With related MSRs | $ | 39,407,600 | $ | 37,524,221 | $ | 41,753,865 | $ | 39,407,600 | ||||||||
Without related MSRs | 11,917,124 | 10,012,639 | 15,584,677 | 11,917,124 | ||||||||||||
$ | 51,324,724 | $ | 47,536,860 | $ | 57,338,542 | $ | 51,324,724 | |||||||||
Number of loans serviced | 362,430 | 344,659 | 387,619 | 362,430 | ||||||||||||
Average delinquency rate | 5.19% | 5.01% | 5.02 | % | 5.19 | % | ||||||||||
Value of MSRs | $ | 134,062 | $ | 123,980 | $ | 147,511 | $ | 134,062 | ||||||||
Loan servicing revenues increased $3.1$11.0 million, or 5.2%17.8%, compared to the firstsecond quarter. The increase reflects a higher loan servicing portfolio. The average servicing portfolio for the three months ended OctoberJanuary 31, 20042005 increased $3.8$6.0 billion, or 8.0%11.7%.
Accretion of residual interests of $32.2Total expenses increased $17.5 million represents an increase of $6.5 million overcompared to the precedingsecond quarter. This increase is primarily due to write-ups$11.2 million in theincreased compensation and benefits as a result of a 4.6% increase in sales associates, coupled with related asset values during the first half of fiscal year 2005.
Total expenses of $175.4 million for the current quarter increased $0.8 million compared to the first quarter.increases in payroll taxes and origination-based incentives. Other expenses increased $5.7$2.5 million for the current quarter, primarily due to a $2.9$5.6 million increase in consulting expenses, a $1.5 million increase in allocated expenses, and increases in depreciation and other expenses. This increasemarketing costs, which was partially offset by a $7.2$3.2 million declinedecrease in compensation and benefits, primarilyconsulting expenses. Costs related to servicing of mortgage loans increased $3.6 million as a result of decreased incentive compensation expenses.a higher average servicing portfolio.
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Pretax income increased $12.7$5.5 million, or 13.5%5.2%, for the three months ended OctoberJanuary 31, 20042005 compared to the preceding quarter.
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Mortgage Services – Operating Statistics | (dollars in 000s) | |||||||
Nine months ended January 31, | 2005 | 2004 | ||||||
Volume of loans originated: | ||||||||
Wholesale (non-prime) | $ | 18,887,536 | $ | 14,740,523 | ||||
Retail:Prime | 637,801 | 945,424 | ||||||
Non-prime | 2,197,898 | 1,323,236 | ||||||
$ | 21,723,235 | $ | 17,009,183 | |||||
Loan characteristics: | ||||||||
Weighted average FICO score(1) | 611 | 608 | ||||||
Weighted average interest rate for borrowers(1) | 7.32 | % | 7.51 | % | ||||
Weighted average loan-to-value(1) | 78.6 | % | 78.2 | % | ||||
Revenue (loan value): | ||||||||
Net gain on sale – gross margin(2) | 2.64 | % | 4.01 | % | ||||
Loan delivery: | ||||||||
Loan sales | $ | 21,653,373 | $ | 16,940,590 | ||||
Execution price(3) | 3.21 | % | 4.14 | % | ||||
Six months ended October 31, | 2004 | 2003 | ||||||
Number of loans originated: | ||||||||
Wholesale (non-prime) | 71,872 | 64,727 | ||||||
Retail: Prime | 3,062 | 5,949 | ||||||
Non-prime | 10,414 | 7,114 | ||||||
85,348 | 77,790 | |||||||
Volume of loans originated: | ||||||||
Wholesale (non-prime) | $ | 11,509,465 | $ | 10,008,341 | ||||
Retail: Prime | 398,934 | 787,987 | ||||||
Non-prime | 1,421,101 | 858,308 | ||||||
$ | 13,329,500 | $ | 11,654,636 | |||||
Loan characteristics: | ||||||||
Weighted average FICO score(1) | 609 | 609 | ||||||
Weighted average interest rate for borrowers(1) | 7.33% | 7.53% | ||||||
Weighted average loan-to-value(1) | 78.1% | 78.2% | ||||||
Revenue (loan value): | ||||||||
Net gain on sale – gross margin(2) | 2.78% | 4.04% | ||||||
Loan delivery: | ||||||||
Loan sales | $ | 13,304,836 | $ | 11,631,790 | ||||
Execution price(3) | 3.43% | 4.18% |
(1) | Represents non-prime production. |
(2) | 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 |
Six months ended October 31, | 2004 | 2003 | ||||||
Components of gains on sales: | ||||||||
Gains on mortgage loans | $ | 370,117 | $ | 471,061 | ||||
Impairment of residual interests | (3,469 | ) | (11,106 | ) | ||||
366,648 | 459,955 | |||||||
Interest income: | ||||||||
Accretion – residual interests | 57,835 | 70,906 | ||||||
Other interest income | 3,884 | 816 | ||||||
61,719 | 71,722 | |||||||
Loan servicing revenue | 120,762 | 99,976 | ||||||
Other | 638 | 1,109 | ||||||
Total revenues | 549,767 | 632,762 | ||||||
Cost of services | 105,175 | 91,188 | ||||||
Compensation and benefits | 145,102 | 116,082 | ||||||
Occupancy | 21,291 | 18,847 | ||||||
Other | 78,459 | 58,790 | ||||||
Total expenses | 350,027 | 284,907 | ||||||
Pretax income | $ | 199,740 | $ | 347,855 | ||||
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Six
Mortgage Services - Operating Results | (in 000s) | ||||||||
Nine months ended January 31, | 2005 | 2004 | |||||||
Components of gains on sales: | |||||||||
Gain on mortgage loans | $ | 544,428 | $ | 685,549 | |||||
Gain (loss) on derivatives | 28,826 | (4,297 | ) | ||||||
Gain on sales of residual interests | — | 17,000 | |||||||
Impairment of residual interests | (8,304 | ) | (26,048 | ) | |||||
564,950 | 672,204 | ||||||||
Interest income: | |||||||||
Accretion - residual interests | 86,618 | 118,389 | |||||||
Other interest income | 7,947 | 3,043 | |||||||
94,565 | 121,432 | ||||||||
Loan servicing revenue | 193,690 | 155,048 | |||||||
Other | 1,205 | 1,677 | |||||||
Total revenues | 854,410 | 950,361 | |||||||
Cost of services | 161,869 | 144,020 | |||||||
Compensation and benefits | 225,287 | 178,956 | |||||||
Occupancy | 32,810 | 27,906 | |||||||
Other | 123,023 | 97,148 | |||||||
Total expenses | 542,989 | 448,030 | |||||||
Pretax income | $ | 311,421 | $ | 502,331 | |||||
Nine months ended OctoberJanuary 31, 20042005 compared to OctoberJanuary 31, 2003
2004
Mortgage Services’ revenues decreased $83.0$96.0 million, or 13.1%10.1%, for the sixnine months ended OctoberJanuary 31, 20042005 compared to the prior year. Revenues decreased primarily as a result of a decline in gains on sales of mortgage loans.
The following table summarizes the key drivers of gains on sales of mortgage loans:
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(dollars in 000s) | ||||||||
Nine months ended January 31, | 2005 | 2004 | ||||||
Application process: | ||||||||
Total number of applications | 232,001 | 194,730 | ||||||
Number of sales associates(1) | 3,523 | 2,649 | ||||||
Closing ratio(2) | 58.9 | % | 58.3 | % | ||||
Originations: | ||||||||
Total number of originations | 136,615 | 113,585 | ||||||
Weighted average interest rate for borrowers (WAC) | 7.32 | % | 7.51 | % | ||||
Average loan size | $ | 159 | $ | 150 | ||||
Total originations | $ | 21,723,235 | $ | 17,009,183 | ||||
Non-prime origination ratio | 97.1 | % | 94.4 | % | ||||
Direct origination expenses, net | $ | 299,549 | $ | 208,315 | ||||
Revenue (loan value): | ||||||||
Net gain on sale – gross margin(3) | 2.64 | % | 4.01 | % | ||||
(dollars in 000s)
Six months ended October 31, | 2004 | 2003 | ||||||
Application process: | ||||||||
Total number of applications | 147,191 | 135,402 | ||||||
Number of sales associates(1) | 3,369 | 2,476 | ||||||
Closing ratio(2) | 58.0% | 57.5% | ||||||
Originations: | ||||||||
Total number of originations | 85,348 | 77,790 | ||||||
Weighted average interest rate for borrowers | 7.33% | 7.53% | ||||||
Average loan size | $ | 156 | $ | 150 | ||||
Total originations | $ | 13,329,500 | $ | 11,654,636 | ||||
Non-prime / prime origination ratio | 32.4 : 1 | 13.8 : 1 | ||||||
Direct origination expenses, net | $ | 189,117 | $ | 130,244 | ||||
Revenue (loan value): | ||||||||
Net gain on sale – gross margin(3) | 2.78% | 4.04% |
Gains Although we continue to grow our origination volumes, up 27.7% over the prior year, gains on sales of mortgage loans declined $100.9$141.1 million as a result of increased price competition and poorer execution in the secondary market and higher loan origination costs.market. Market interest rates have increased 106 basis points sinceto 3.64% from 1.88% in early April howeverand our WAC has only increased 27 basis points from 7.06% at April 30, 2004 resulting in a decline into 7.32% at January 31, 2005. Because our WAC was not more aligned with market rates, our gross margin of 126declined 137 basis points from last year. Additionally, direct origination expenses increased $58.9To mitigate the risk of short-term changes in market interest rates, we use interest rate swaps and forward loan sale commitments. During the current year, we recorded a net $28.8 million primarily duein gains, compared to increasesa net loss of $4.3 million in broker incentives and origination volume. Amountsthe prior year, related to our various derivative instruments.
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As discussed previously, we reclassified accretion on our beneficial interest in Trusts from interest income to gainsgain on salessale. Amounts reclassified for the sixnine months ended OctoberJanuary 31, 20032004 totaled $68.3$125.9 million. This change had no impact on our net income as previously reported.
In the prior year we recorded $17.0 million in gains on sales of previously securitized residual interests, while no similar transaction occurred in the current year.
Impairments of residual interests in securitizations of $3.5$8.3 million were recognized in the current period, compared to $11.1$26.0 million for the sixnine months ended OctoberJanuary 31, 2003.2004.
The following table summarizes the key drivers of loan servicing revenues:
(dollars in 000s)
Six months ended October 31, | 2004 | 2003 | ||||||||||||||
(dollars in 000s) | (dollars in 000s) | |||||||||||||||
Nine months ended January 31, | 2005 | 2004 | ||||||||||||||
Average servicing portfolio: | ||||||||||||||||
With related MSRs | $ | 38,436,169 | $ | 29,708,420 | $ | 39,593,946 | $ | 30,931,506 | ||||||||
Without related MSRs | 10,998,659 | 5,188,500 | 12,586,192 | 5,975,852 | ||||||||||||
$ | 49,434,828 | $ | 34,896,920 | $ | 52,180,138 | $ | 36,907,358 | |||||||||
Number of loans serviced | 362,430 | 295,636 | 387,619 | 308,305 | ||||||||||||
Average delinquency rate | 5.10% | 6.43% | 5.03 | % | 6.27 | % | ||||||||||
Value of MSRs | $ | 134,062 | $ | 111,960 | $ | 147,511 | $ | 106,196 | ||||||||
Loan servicing revenues increased $20.8$38.6 million, or 20.8%24.9%, compared to the prior year. The increase reflects a higher loan-servicing portfolio. The average servicing portfolio for the sixnine months ended OctoberJanuary 31, 20042005 increased $14.5$15.3 billion, or 41.7%41.4%.
Accretion of residual interests of $57.8$86.6 million for the sixnine months ended OctoberJanuary 31, 20042005 represents a decrease of $13.1$31.8 million from the prior year. 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 the first halfnine months of fiscal year 2005, our residual interests continued to perform better than expected compared to internal valuation models. We recorded favorable pretax mark-to-market adjustments, which increased the fair value of our residual interests $113.5$132.3 million during the year. These adjustments were recorded, net of write-downs of $24.7$33.6 million and deferred taxes of $33.9$37.7 million, in other comprehensive income and will be accreted into income throughout the remaining life of those residual interests.
Total expenses for the sixnine months ended OctoberJanuary 31, 2004,2005, increased $65.1$95.0 million, or 22.9%21.2%, over the prior year. This increase is primarily due to $29.0$46.3 million in increased compensation and benefits as a
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result of a 36.1%33.0% increase in sales associates. We did not achieveassociates, reflecting the level of loan productionoverall growth in the current year that we were staffed to support.operations. Other expenses increased $19.7$25.9 million for the current period, primarily due to a $6.1an $8.9 million increase in consulting expenses, a $3.7 million increase in allocated expenses, $2.4 million in additional travel expenses, and increases in depreciation and othertravel expenses. Costs related to servicing of mortgage loans increased $14.0$17.8 million as a result of a higher average servicing portfolio.
Pretax income decreased $148.1$190.9 million to $199.7$311.4 million for the sixnine months ended OctoberJanuary 31, 2004.2005.
Fiscal 2005 outlook
Due to continued pressure on our margins, our Mortgage Services segment fiscal year 2005 outlook has declined from the discussion in our April 30, 2004 Form 10-K and our July 31, 2004 Form 10-Q.10-K. Based on these assumptions, we expect our mortgage segment pretax income to decline approximately 30% from fiscal year 2004, excluding the gain on sale of previously securitized residual interests. We are investing in technology and seeking other alternatives to lower our cost of origination. Beginning late in our fourth quarter and then more meaningfully in fiscal year 2006, we expect to realize a 50 to 75 basis point improvement in our overalltotal cost of origination, including the effect of potentially higher origination volumes.
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BUSINESS SERVICES
This segment offers middle-market companies accounting, tax and consulting services, wealth management, retirement resources, payroll and benefits services, corporate finance and financial process outsourcing.
Business Services – Operating Statistics | |||||||||||||||||
Three months ended January 31, | Nine months ended January 31, | ||||||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||||||
Accounting, tax and consulting: | |||||||||||||||||
Chargeable hours | 641,009 | 580,746 | 1,852,346 | 1,682,073 | |||||||||||||
Chargeable hours per person | 332 | 322 | 935 | 904 | |||||||||||||
Net collected rate per hour | $ | 134 | $ | 126 | $ | 129 | $ | 122 | |||||||||
Average margin per person | $ | 25,194 | $ | 23,117 | $ | 64,621 | $ | 59,126 | |||||||||
Business Services – Operating Results | (in 000s) | ||||||||||||||||
Three months ended January 31, | Nine months ended January 31, | ||||||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||||||
Service revenues: | |||||||||||||||||
Accounting, tax and consulting | $ | 90,880 | $ | 74,680 | $ | 259,207 | $ | 214,544 | |||||||||
Capital markets | 17,631 | 19,287 | 48,309 | 53,789 | |||||||||||||
Payroll, benefits and retirement services | 6,748 | 5,527 | 16,280 | 14,977 | |||||||||||||
Other services | 7,809 | 4,754 | 20,212 | 13,681 | |||||||||||||
123,068 | 104,248 | 344,008 | 296,991 | ||||||||||||||
Other | 9,804 | 8,045 | 27,013 | 22,825 | |||||||||||||
Total revenues | 132,872 | 112,293 | 371,021 | 319,816 | |||||||||||||
Cost of services: | |||||||||||||||||
Compensation and benefits | 68,730 | 56,707 | 206,631 | 165,306 | |||||||||||||
Occupancy | 6,572 | 4,935 | 17,111 | 15,393 | |||||||||||||
Other | 8,129 | 8,386 | 31,151 | 24,143 | |||||||||||||
83,431 | 70,028 | 254,893 | 204,842 | ||||||||||||||
Selling, general and administrative | 43,505 | 40,310 | 125,176 | 122,430 | |||||||||||||
Total expenses | 126,936 | 110,338 | 380,069 | 327,272 | |||||||||||||
Pretax income (loss) | $ | 5,936 | $ | 1,955 | $ | (9,048 | ) | $ | (7,456 | ) | |||||||
Business Services – Operating Statistics
Three months ended October 31, | Six months ended October 31, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
Accounting, tax and consulting: | ||||||||||||||||
Chargeable hours | 674,302 | 584,941 | 1,211,337 | 1,101,327 | ||||||||||||
Chargeable hours per person | 322 | 309 | 601 | 581 | ||||||||||||
Net collected rate per hour | $ | 129 | $ | 120 | $ | 126 | $ | 119 | ||||||||
Average margin per person | $ | 22,706 | $ | 20,177 | $ | 39,134 | $ | 35,961 |
Three months ended October 31, | Six months ended October 31, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
Service revenues: | ||||||||||||||||
Accounting, tax and consulting | $ | 85,298 | $ | 68,669 | $ | 153,658 | $ | 129,570 | ||||||||
Capital markets | 14,895 | 17,870 | 30,672 | 34,500 | ||||||||||||
Payroll, benefits and retirement services | 4,827 | 4,864 | 9,481 | 9,422 | ||||||||||||
Other services | 3,230 | 1,755 | 5,693 | 1,755 | ||||||||||||
108,250 | 93,158 | 199,504 | 175,247 | |||||||||||||
Other | 20,797 | 15,866 | 38,645 | 32,276 | ||||||||||||
Total revenues | 129,047 | 109,024 | 238,149 | 207,523 | ||||||||||||
Cost of services: | ||||||||||||||||
Compensation and benefits | 71,643 | 56,429 | 135,740 | 107,512 | ||||||||||||
Occupancy | 5,933 | 5,510 | 10,539 | 10,457 | ||||||||||||
Other | 8,887 | 7,375 | 17,428 | 14,177 | ||||||||||||
86,463 | 69,314 | 163,707 | 132,146 | |||||||||||||
Selling, general and administrative | 47,497 | 42,442 | 89,426 | 84,788 | ||||||||||||
Total expenses | 133,960 | 111,756 | 253,133 | 216,934 | ||||||||||||
Pretax loss | $ | (4,913 | ) | $ | (2,732 | ) | $ | (14,984 | ) | $ | (9,411 | ) | ||||
Three months ended OctoberJanuary 31, 20042005 compared to OctoberJanuary 31, 2003
2004
Business Services’ revenues for the three months ended OctoberJanuary 31, 20042005 increased $20.0$20.6 million, or 18.4%18.3%, from the prior year. This increase was primarily due to a $16.6$16.2 million increase in accounting,
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tax and consulting revenues resulting from ana 6.3% increase in the net collected rate per hour and a 15.3%10.4% increase in chargeable hours. The increase in chargeable hours is primarily due to the favorable market conditions for all of our core services and thestrong demand for consulting and risk management services. Other service revenues increased $1.5$3.1 million as a result of growth in our financial process outsourcing business.
business and wealth management services. Capital markets revenues declined $1.7 million as a result of an 11.5% decrease in the number of business valuation projects. Other revenues increased $4.9$1.8 million as a result of increases in reimbursable expenses billedcomputer hardware and software sales to clients and contractor revenues. Capital markets revenues declined $3.0 million as a result of a 4.2% decrease in the number of business valuation projects.clients.
Total expenses increased $22.2$16.6 million, or 19.9%15.0%, for the three months ended OctoberJanuary 31, 20042005 compared to the prior year. Compensation and benefits increased $15.2$12.0 million, primarily as a result of increases in the average wage per employee, which is being driven by marketplace competition for professional staff, and in the number of personnel. Selling, general and administrative expenses increased $5.1$3.2 million primarily due to increased personnel recruiting expenses and additional costs associated with our strategic growthbusiness development initiatives. A portion of the increases in each expense category isHigher expenses are also attributable to investments we are making in early-stage businesses within this segment.
The pretax lossPretax income for the three months ended OctoberJanuary 31, 20042005 was $4.9$5.9 million compared to $2.7$2.0 million in the prior year.
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Due to the seasonal nature of this segment’s business, operating results for the three months ended OctoberJanuary 31, 20042005 are not comparable to the three months ended JulyOctober 31, 2004 and are not indicative of the expected results for the entire fiscal year.
SixNine months ended OctoberJanuary 31, 20042005 compared to OctoberJanuary 31, 2003
2004
Business Services’ revenues for the sixnine months ended OctoberJanuary 31, 20042005 increased $30.6$51.2 million, or 14.8%16.0%, from the prior year. This increase was primarily due to a $24.1$44.7 million increase in accounting, tax and consulting revenues resulting from ana 5.7% increase in the net collected rate per hour and a 10.0%10.1% increase in chargeable hours. Additionally, reimbursable expenses and contractor revenues contributed $2.3 million and $3.8 million, respectively, to this increase. Other service revenues increased $3.9$6.5 million due to our wealth management services and the acquisition of our financial process outsourcing business in the second quarter of last year, coupled with baseline growth in this business. Capital markets revenues declined $5.5 million as a result of a 13.0% decrease in the number of business valuation projects. Other revenues increased $6.4$4.2 million as a result of increases in reimbursable expenses billednetwork product fees and computer hardware and software sales to clients and contractor revenues. Capital markets revenues declined $3.8 million as a result of a 13.9% decrease in the number of business valuation projects.clients.
Total expenses increased $36.2$52.8 million, or 16.7%16.1%, for the sixnine months ended OctoberJanuary 31, 20042005 compared to the prior year. Compensation and benefits increased $28.2$41.3 million, primarily as a result of increases in the average wage per employee, which is being driven by marketplace competition for professional staff, and the number of personnel. Other cost of services increased as a result of higher legal fees and settlements, coupled with higher reimbursable expenses billed to clients.clients and contractor fees. Selling, general and administrative expenses increased $4.6$2.7 million primarily due to increased personnel recruiting expenses and additional costs associated with our strategic growth initiatives. A portion of the increases in each expense category isHigher expenses are also attributable to investments we are making in early-stage businesses within this segment.
The pretax loss for the sixnine months ended OctoberJanuary 31, 20042005 was $15.0$9.0 million compared to $9.4$7.5 million in the prior year.
Fiscal 2005 outlook
Our fiscal year 2005 outlook for our Business Services segment is unchanged from the discussion in our April 30, 2004 Form 10-K and our JulyOctober 31, 2004 Form 10-Q.
INVESTMENT SERVICES
This segment is primarily engaged in offering advice-based brokerage services and investment planning. Our integration of investment advice and new service offerings are allowing us to shift our focus from a transaction-based client relationship to a more advice-based focus.
-27--30-
Investment Servic – Operating Statistics | ||||||||||||
Three months ended | January 31, 2005 | January 31, 2004 | October 31, 2004 | |||||||||
Customer trades(1) | 245,612 | 272,003 | 192,909 | |||||||||
Customer daily average trades | 3,899 | 4,459 | 3,014 | |||||||||
Average revenue per trade(2) | $ | 120.62 | $ | 113.61 | $ | 125.13 | ||||||
Customer accounts:(3) | ||||||||||||
Traditional brokerage | 431,902 | 467,710 | 444,770 | |||||||||
Express IRAs | 295,676 | 241,116 | 334,928 | |||||||||
727,578 | 708,826 | 779,698 | ||||||||||
Ending balance of assets under administration (billions) | $ | 28.4 | $ | 27.5 | $ | 27.2 | ||||||
Average assets per traditional brokerage account | $ | 65,339 | $ | 58,256 | $ | 60,225 | ||||||
Average margin balances (millions) | $ | 596 | $ | 568 | $ | 590 | ||||||
Average customer payable balances (millions) | $ | 989 | $ | 1,028 | $ | 962 | ||||||
Number of advisors | 1,013 | 960 | 982 | |||||||||
Included in the numbers above are the following relating to fee-based accounts: | ||||||||||||
Customer household accounts | 7,263 | 5,705 | 7,046 | |||||||||
Average revenue per account | $ | 2,149 | $ | 2,021 | $ | 2,044 | ||||||
Ending balance of assets under administration (millions) | $ | 1,911 | $ | 1,342 | $ | 1,755 | ||||||
Average assets per active account | $ | 248,400 | $ | 235,232 | $ | 249,068 | ||||||
Investment Services – Operating Results | (in 000s) | ||||||||||||
Three months ended | January 31, 2005 | January 31, 2004 | October 31, 2004 | ||||||||||
Service revenue: | |||||||||||||
Transactional revenue | $ | 24,654 | $ | 26,504 | $ | 19,988 | |||||||
Annuitized revenue | 18,382 | 15,324 | 17,199 | ||||||||||
Production revenue | 43,036 | 41,828 | 37,187 | ||||||||||
Other service revenue | 7,000 | 8,568 | 6,527 | ||||||||||
50,036 | 50,396 | 43,714 | |||||||||||
Margin interest revenue | 11,975 | 8,362 | 10,038 | ||||||||||
Less: interest expense | (1,090 | ) | (248 | ) | (541 | ) | |||||||
Net interest revenue | 10,885 | 8,114 | 9,497 | ||||||||||
Other | 93 | (1,005 | ) | 9 | |||||||||
Total revenues(1) | 61,014 | 57,505 | 53,220 | ||||||||||
Cost of services: | |||||||||||||
Compensation and benefits | 28,986 | 27,031 | 27,074 | ||||||||||
Occupancy | 5,913 | 5,123 | 4,753 | ||||||||||
Depreciation | 1,052 | 1,978 | 1,089 | ||||||||||
Other | 4,478 | 4,001 | 3,447 | ||||||||||
40,429 | 38,133 | 36,363 | |||||||||||
Selling, general and administrative | 38,897 | 32,183 | 41,423 | ||||||||||
Total expenses | 79,326 | 70,316 | 77,786 | ||||||||||
Pretax loss | $ | (18,312 | ) | $ | (12,811 | ) | $ | (24,566 | ) | ||||
Investment Services – Operating Statistics
Three months ended | October 31, 2004 | October 31, 2003 | July 31, 2004 | |||||||||
Customer trades(1) | 192,909 | 232,293 | 205,948 | |||||||||
Customer daily average trades | 3,014 | 3,574 | 3,269 | |||||||||
Average revenue per trade(2) | $ | 125.13 | $ | 116.22 | $ | 119.71 | ||||||
Active accounts: | ||||||||||||
Traditional brokerage | 444,770 | 474,289 | 454,147 | |||||||||
Express IRAs | 334,928 | 228,110 | 337,583 | |||||||||
779,698 | 702,399 | 791,730 | ||||||||||
Ending balance of assets under administration (billions) | $ | 27.2 | $ | 25.7 | $ | 26.6 | ||||||
Average assets per active account | $ | 34,924 | $ | 36,589 | $ | 33,592 | ||||||
Average margin balances (millions) | $ | 590 | $ | 514 | $ | 598 | ||||||
Average customer payable balances (millions) | $ | 962 | $ | 959 | $ | 1,012 | ||||||
Number of advisors | 982 | 928 | 997 | |||||||||
Included in the numbers above are the following relating to fee-based accounts: | ||||||||||||
Customer accounts | 7,046 | 5,174 | 7,688 | |||||||||
Average revenue per account | $ | 2,044 | $ | 1,897 | $ | 1,848 | ||||||
Ending balance of assets under administration (millions) | $ | 1,755 | $ | 1,088 | $ | 1,547 | ||||||
Average assets per active account | $ | 249,068 | $ | 210,290 | $ | 201,198 |
Three months ended | October 31, 2004 | October 31, 2003 | July 31, 2004 | |||||||||
Service revenue: | ||||||||||||
Transactional revenue | $ | 19,988 | $ | 22,698 | $ | 19,952 | ||||||
Annuitized revenue | 17,199 | 13,978 | 18,533 | |||||||||
Production revenue | 37,187 | 36,676 | 38,485 | |||||||||
Other service revenue | 6,527 | 9,878 | 6,262 | |||||||||
43,714 | 46,554 | 44,747 | ||||||||||
Margin interest revenue | 10,038 | 8,057 | 8,760 | |||||||||
Less: interest expense | (541 | ) | (207 | ) | (299 | ) | ||||||
Net interest revenue | 9,497 | 7,850 | 8,461 | |||||||||
Other | 9 | (1,908 | ) | 74 | ||||||||
Total revenues(1) | 53,220 | 52,496 | 53,282 | |||||||||
Cost of services: | ||||||||||||
Compensation and benefits | 27,074 | 21,485 | 28,848 | |||||||||
Occupancy | 4,753 | 4,189 | 5,688 | |||||||||
Depreciation | 1,089 | 1,665 | 1,064 | |||||||||
Other | 3,447 | 4,328 | 3,755 | |||||||||
36,363 | 31,667 | 39,355 | ||||||||||
Selling, general and administrative | 41,423 | 36,165 | 32,198 | |||||||||
Total expenses | 77,786 | 67,832 | 71,553 | |||||||||
Pretax loss | $ | (24,566 | ) | $ | (15,336 | ) | $ | (18,271 | ) | |||
Three months ended OctoberJanuary 31, 20042005 compared to OctoberJanuary 31, 2003
2004
Investment Services’ revenues, net of interest expense, for the three months ended OctoberJanuary 31, 20042005 increased $0.7$3.5 million, or 1.4%6.1%.
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Production revenue increased $1.2 million, or 2.9%, over the prior year. Transactional revenue, which is based on individual securities transactions, decreased $2.7$1.9 million, or 11.9%7.0%, from the prior year due primarily to a 17.0%15.8% decline in transactional trading volume resulting from the weak
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investment climate.volume. This decline was partially offset by an increase in average revenue per trade of 7.7% over the prior year.
trade. Annuitized revenue, which is based on sales of mutual fund,funds, insurance, fee based products and unit investment trusts, increased $3.2$3.1 million, or 23.0%20.0%, due to increased sales of annuities and mutual funds. The shift in revenues between transactional and annuitized revenues illustrates our continued move toward an advice-based focus.
ProductivityAnnualized productivity averaged approximately $148,000$172,000 per advisor during the current quarter compared to $155,000$185,000 per advisor in the prior year. This decline isDeclining productivity was primarily attributable to market conditions.
Other service revenue declined $3.4 million, or 33.9%, from the prior year due to lower underwriting fees related to fixed income products.advisor attrition.
Margin interest revenue increased 24.6%$3.6 million, or 43.2%, from the prior year, which is primarilyas a result of a 14.8%4.9% increase in average margin balances and slightly higher rates.interest rates earned.
Cost of services increased $4.7$2.3 million, or 14.8%6.0%, primarily as a result of $5.6$2.0 million of additional compensation and benefits. This increase is primarily due to higher commission rates than the prior year and financial incentives for new advisors.
Selling, general and administrative expenses increased $5.3$6.7 million, or 20.9%, over the prior year primarily as the result of a $6.0 million write-down of a branch office facility and an increase of $1.7 million in legal expenses, partially offset by gains of $1.0$2.2 million on the disposition of certain assets in the prior year, an increase of $2.1 million in legal expenses and a $1.2$1.8 million decrease in incentive compensation expenses.additional stock-based compensation.
The pretax loss for Investment Services for the secondthird quarter of fiscal year 2005 was $24.6$18.3 million compared to the prior year loss of $15.3$12.8 million.
Three months ended January 31, 2005 compared to October 31, 2004 compared to July 31, 2004
Investment Services’ revenues, net of interest expense, for the three months ended OctoberJanuary 31, 2004 were essentially flat2005 increased $7.8 million, or 14.6% compared to the preceding quarter.
Production revenue increased $5.8 million, or 15.7%, over the second quarter. Transactional revenue was also flatincreased $4.7 million, or 23.3%, compared to the preceding quarter, primarily due to a 6.3% decline31.1% increase in transactional trading volume partially offset by a 4.5% increasedecline in average revenue per trade. Annuitized revenues declined $1.3rose $1.2 million, or 7.2%6.9%, due to decreasedincreased mutual fund sales of annuities and mutual funds.
trailer revenue. A total of 7286 new advisors were recruited during the quarter and recruiting efforts are expected to increase throughout the year. However, ourquarter. Our total advisor count declinedincreased from 997982 to 9821,013 during the period as a result of our recruiting efforts were offset byand declining advisor attrition.
Margin interest revenue increased 14.6%$1.9 million, or 19.3%, from the preceding quarter, which is primarily a result of higher interest rates partially offset by a 1.3% decrease in average margin balances.earned.
Cost of services declined $3.0increased $4.1 million, primarilyor 11.2%, principally due to a $1.8$1.9 million reductionrise in compensation and benefits, primarily due to lowerresulting from higher production revenues.
Selling, general and administrative expenses increased $9.2decreased $2.5 million, from the preceding quarter,or 6.1%, primarily due to thea $6.0 million write-down of a branch office facility decreasedduring the second quarter, partially offset by gains on the disposition of certain assets during the second quarter and increased legal expenses.$1.5 million in additional stock-based compensation recorded in the current quarter.
The pretax loss for the Investment Services segment was $24.6$18.3 million, compared to a loss of $18.3$24.6 million in the firstsecond quarter.
-29--32-
Investment Services – Operating Statistics | |||||||||
Nine months ended January 31, | 2005 | 2004 | |||||||
Customer trades(1) | 644,469 | 744,765 | |||||||
Customer daily average trades | 3,410 | 3,859 | |||||||
Average revenue per trade(2) | $ | 121.68 | $ | 118.74 | |||||
Customer accounts:(3) | |||||||||
Traditional brokerage | 431,902 | 467,710 | |||||||
Express IRAs | 295,676 | 241,116 | |||||||
727,578 | 708,826 | ||||||||
Ending balance of assets under administration (billions) | $ | 28.4 | $ | 27.5 | |||||
Average assets per traditional brokerage account | $ | 65,339 | $ | 58,256 | |||||
Average margin balances (millions) | $ | 595 | $ | 528 | |||||
Average customer payable balances (millions) | $ | 988 | $ | 963 | |||||
Number of advisors | 1,013 | 960 | |||||||
Included in the numbers above are the following relating to fee-based accounts: | |||||||||
Customer household accounts | 7,263 | 5,705 | |||||||
Average revenue per account | $ | 2,039 | $ | 1,734 | |||||
Ending balance of assets under administration (millions) | $ | 1,911 | $ | 1,342 | |||||
Average assets per active account | $ | 248,400 | $ | 235,232 | |||||
Investment Services – Operating Results | (in 000s) | ||||||||
Nine months ended January 31, | 2005 | 2004 | |||||||
Service revenue: | |||||||||
Transactional revenue | $ | 64,594 | $ | 74,658 | |||||
Annuitized revenue | 54,114 | 42,145 | |||||||
Production revenue | 118,708 | 116,803 | |||||||
Other service revenue | 19,789 | 26,422 | |||||||
138,497 | 143,225 | ||||||||
Margin interest revenue | 30,773 | 24,949 | |||||||
Less: interest expense | (1,930 | ) | (1,065 | ) | |||||
Net interest revenue | 28,843 | 23,884 | |||||||
Other | 176 | (731 | ) | ||||||
Total revenues(1) | 167,516 | 166,378 | |||||||
Cost of services: | |||||||||
Compensation and benefits | 84,908 | 73,905 | |||||||
Occupancy | 16,354 | 15,427 | |||||||
Depreciation | 3,205 | 5,652 | |||||||
Other | 11,680 | 12,331 | |||||||
116,147 | 107,315 | ||||||||
Selling, general and administrative | 112,518 | 100,967 | |||||||
Total expenses | 228,665 | 208,282 | |||||||
Pretax loss | $ | (61,149 | ) | $ | (41,904 | ) | |||
Investment Services – Operating Statistics
Six months ended October 31, | 2004 | 2003 | ||||||
Customer trades(1) | 398,857 | 472,762 | ||||||
Customer daily average trades | 3,166 | 3,582 | ||||||
Average revenue per trade(2) | $ | 122.33 | $ | 121.69 | ||||
Active accounts: | ||||||||
Traditional brokerage | 444,770 | 474,289 | ||||||
Express IRAs | 334,928 | 228,110 | ||||||
779,698 | 702,399 | |||||||
Ending balance of assets under administration (billions) | $ | 27.2 | $ | 25.7 | ||||
Average assets per active account | $ | 34,924 | $ | 36,589 | ||||
Average margin balances (millions) | $ | 594 | $ | 508 | ||||
Average customer payable balances (millions) | $ | 987 | $ | 931 | ||||
Number of advisors | 982 | 928 | ||||||
Included in the numbers above are the following relating to fee-based accounts: | ||||||||
Customer accounts | 7,046 | 5,174 | ||||||
Average revenue per account | $ | 2,030 | $ | 1,753 | ||||
Ending balance of assets under administration (millions) | $ | 1,755 | $ | 1,088 | ||||
Average assets per active account | $ | 249,068 | $ | 210,290 |
Six months ended October 31, | 2004 | 2003 | ||||||
Service revenue: | ||||||||
Transactional revenue | $ | 39,940 | $ | 48,154 | ||||
Annuitized revenue | 35,732 | 26,821 | ||||||
Production revenue | 75,672 | 74,975 | ||||||
Other service revenue | 12,789 | 17,854 | ||||||
88,461 | 92,829 | |||||||
Margin interest revenue | 18,798 | 16,587 | ||||||
Less: interest expense | (840 | ) | (817 | ) | ||||
Net interest revenue | 17,958 | 15,770 | ||||||
Other | 83 | 274 | ||||||
Total revenues(1) | 106,502 | 108,873 | ||||||
Cost of services: | ||||||||
Compensation and benefits | 55,922 | 46,874 | ||||||
Occupancy | 10,441 | 10,304 | ||||||
Depreciation | 2,153 | 3,674 | ||||||
Other | 7,202 | 8,330 | ||||||
75,718 | 69,182 | |||||||
Selling, general and administrative | 73,621 | 68,784 | ||||||
Total expenses | 149,339 | 137,966 | ||||||
Pretax loss | $ | (42,837 | ) | $ | (29,093 | ) | ||
SixNine months ended OctoberJanuary 31, 20042005 compared to OctoberJanuary 31, 2003
2004
Investment Services’ revenues, net of interest expense, for the sixnine months ended OctoberJanuary 31, 2004 decreased $2.42005 increased $1.1 million, or 2.2%0.7%. The decrease is primarily due to
Production revenue increased $1.9 million, or 1.6%, over the weak investment climate.
prior year. Transactional revenue decreased $8.2$10.1 million, or 17.1%13.5%, from the prior year due primarily to a 15.6%20.0% decline in transactional
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trading volume. This declinevolume, which was marginallypartially offset by an increase in the average revenue per trade.
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Annuitized revenues increased $8.9$12.0 million, or 33.2%28.4%, due to increased sales of annuities and mutual funds. The shift in revenues from transactional to annuitized demonstrates our continued move toward an advice-based focus. Additionally, we are seeing our new recruits coming in with more of an advice-based background, which will further support our efforts.
Other service revenue declined $5.1$6.6 million, or 28.4%25.1%, from the prior year due to fewer fixed income underwriting offerings.offerings and Express IRA revenues now being recorded in Tax Services.
Margin interest revenue increased 13.3%$5.8 million, or 23.3%, from the prior year, which is primarilyas a result of a 16.9%12.7% increase in average margin balances.balances and higher interest rates earned. Margin balances have increased from an average of $508$528 million for the sixnine months ended OctoberJanuary 31, 20032004 to $594$595 million in the current period.
Total expensesCost of services increased $11.4$8.8 million, or 8.2%, primarily as a result of a $6.5 million increase in cost of services. During the current year we incurred $9.0due to $11.0 million of additional compensation and benefitsbenefits. This increase is primarily due to a higher average commission rate than the prior year and financial incentives for new advisors. This increase was partially offset by a decline in depreciation costs as a result of building sales and asset roll offs related to the consolidation of field offices. Other cost of services declined as a result of a reduction in property taxes as field offices were sold over the past year.move from owned office facilities to leased facilities.
Selling, general and administrative expenses increased $4.8$11.6 million, or 11.4%, over the prior year primarily as the result of the $6.0 million write-down of a branch office facility and an increase of $2.7$5.0 million in legal expenses. This increase was partially offset by a decrease in incentive compensation expenses and gains of $4.2 million on the disposition of certain assets.
The pretax loss for Investment Services was $42.8$61.1 million compared to the prior year loss of $29.1$41.9 million.
Fiscal 2005 outlook
In our April 30, 2004 Form 10-K and our July 31, 2004 Form 10-Q, we indicated our goalwe believed a key to this segment's profitability was to hire between 250the recruitment and 300retention of experienced advisors byfinancial advisors. Our recruiting efforts during the end of fiscal year 2005. As of the end of our second quarter, we have achieved our planned recruiting levels. We remain optimistic that we will reach our year-end recruiting goal, however we are experiencing higherimproved. However, advisor attrition remains consistent with industry levels and, as a result, recruitment efforts have been fully offset by attrition rates that were higher than planned. We have expanded our partner programs with Tax Services, and have both licensed and unlicensed tax professionals teamed with financial advisors. We are planning for improvements in this business as we planned. Additionally, we indicated that we expected to see continued financial improvements, but still report a loss for fiscal year 2005.better align this segment’s cost structure with its revenue stream. Given our performance to date and revised internal forecasts, we expect our fiscal year 2005 pretax loss to be slightly higherapproximately 25% larger than the prior year.
CORPORATE
This segment consists primarily of corporate support departments, which provide services to our operating segments. These support departments consist of marketing, information technology, facilities, human resources, executive, legal, finance, government relations and corporate communications. Support department costs are generally allocated to our operating segments. Our captive insurance and franchise financing and small business initiative subsidiaries are also included within this segment.
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Corporate – Operating Results | Corporate – Operating Results | (in 000s) | |||||||||||||||||||||||||||||||
Three months ended January 31, | Nine months ended January 31, | ||||||||||||||||||||||||||||||||
Three months ended October 31, | Six months ended October 31, | 2005 | 2004 | 2005 | 2004 | ||||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | ||||||||||||||||||||||||||||||
Operating revenues | $ | 2,432 | $ | 2,253 | $ | 6,865 | $ | 4,981 | $ | 3,425 | $ | 2,332 | $ | 10,290 | $ | 7,313 | |||||||||||||||||
Eliminations | (1,725 | ) | (1,565 | ) | (4,710 | ) | (2,965 | ) | (2,123 | ) | (1,642 | ) | (6,833 | ) | (4,607 | ) | |||||||||||||||||
Total revenues | 707 | 688 | 2,155 | 2,016 | 1,302 | 690 | 3,457 | 2,706 | |||||||||||||||||||||||||
Corporate expenses: | |||||||||||||||||||||||||||||||||
Compensation and benefits | 2,681 | 930 | 6,122 | 3,999 | 1,747 | 2,828 | 7,869 | 6,827 | |||||||||||||||||||||||||
Interest expense on acquisition debt | 17,515 | 17,074 | 34,658 | 34,746 | |||||||||||||||||||||||||||||
Interest expense | 20,936 | 18,764 | 55,672 | 52,119 | |||||||||||||||||||||||||||||
Other | 10,226 | 1,638 | 17,014 | 8,954 | 10,530 | 9,738 | 27,466 | 20,083 | |||||||||||||||||||||||||
30,422 | 19,642 | 57,794 | 47,699 | 33,213 | 31,330 | 91,007 | 79,029 | ||||||||||||||||||||||||||
Support departments: | |||||||||||||||||||||||||||||||||
Information technology | 27,234 | 26,738 | 52,412 | 49,951 | 29,023 | 30,745 | 81,435 | 80,696 | |||||||||||||||||||||||||
Marketing | 7,691 | 5,430 | 11,262 | 8,094 | 46,030 | 44,513 | 57,292 | 52,607 | |||||||||||||||||||||||||
Finance | 8,706 | 8,835 | 17,513 | 15,734 | 9,107 | 8,406 | 26,620 | 24,140 | |||||||||||||||||||||||||
Other | 26,366 | 17,192 | 46,595 | 28,015 | 31,584 | 22,843 | 78,179 | 50,858 | |||||||||||||||||||||||||
69,997 | 58,195 | 127,782 | 101,794 | 115,744 | 106,507 | 243,526 | 208,301 | ||||||||||||||||||||||||||
Allocation of support departments | (69,995 | ) | (58,021 | ) | (127,799 | ) | (101,798 | ) | (117,297 | ) | (106,593 | ) | (245,096 | ) | (208,391 | ) | |||||||||||||||||
Investment income, net | 1,044 | 687 | 2,176 | 2,254 | |||||||||||||||||||||||||||||
Other income, net | 18,399 | 1,227 | 20,575 | 3,481 | |||||||||||||||||||||||||||||
Pretax loss | $ | (28,673 | ) | $ | (18,441 | ) | $ | (53,446 | ) | $ | (43,425 | ) | $ | (11,959 | ) | $ | (29,327 | ) | $ | (65,405 | ) | $ | (72,752 | ) | |||||||||
Three months ended OctoberJanuary 31, 20042005 compared to OctoberJanuary 31, 2003
2004
Corporate expenses increased $10.8$1.9 million primarily due to new business development activities that resulted in higher allocationsinterest expense, resulting from the information technology, legalhigher interest rates and human resource departments, and increases in consulting and insurance costs.higher average debt balances.
MarketingOther support department expenses increased $2.3$8.7 million, or 41.6%, primarily due to additional advertising for tax courses. Other department expenses increased primarily due to $3.7$5.7 million of additional stock-based compensation expenses and increases in the cost of employee insurance and supply sales to franchises.
Other income increased $17.2 million primarily as a result of a $16.7 million legal recovery we received during the current quarter.
The pretax loss was $28.7$12.0 million, compared with last year’s secondthird quarter loss of $18.4$29.3 million.
Due to the nature of this segment, the three months ended OctoberJanuary 31, 20042005 are not comparable to the three months ended JulyOctober 31, 2004 and are not indicative of the expected results for the entire fiscal year.
SixNine months ended OctoberJanuary 31, 20042005 compared to OctoberJanuary 31, 2003
2004
Corporate expenses increased $10.1$12.0 million primarily due to new business development activities that resulted in increases in consulting and insurance costs, as well as increased allocations from the information technology, legal and human resource departments.
Information technology department expenses increased $2.5 million, or 4.9%, primarily due to an increase in resources needed to support additional projects on behalf of operating segments and other support departments. Marketing department expenses increased $3.2$4.7 million, or 39.1%8.9%, primarily due to additional advertising for tax courses.marketing efforts in the current year. Other support department expenses increased $27.3 million, primarily due to $7.2$14.1 million of additional stock-based compensation expenses, increases in the cost of employee insurance and additional supply sales to the operating segments.
Other income increased $17.1 million primarily as a result of the $16.7 million legal recovery we received during the current year.
The pretax loss was $53.4$65.4 million, compared with last year’s loss of $43.4$72.8 million.
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FINANCIAL CONDITION
These comments should be read in conjunction with the condensed consolidated balance sheets and condensed consolidated statements of cash flows found on pages 1 and 3, respectively.
CAPITAL RESOURCES & LIQUIDITY BY SEGMENT
Our sources of capital include cash from operations, issuances of common stock and debt. We use capital primarily to fund working capital requirements, pay dividends, repurchase our shares and acquire businesses.
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Cash From Operations.Cash used in operations totaled $675.1 million$1.6 billion and $463.4 million$1.0 billion for the sixnine months ended OctoberJanuary 31, 20042005 and 2003,2004, respectively. The increase in cash used in operating activities is primarily due to Tax Servicesincreases in receivables, principally participations in RALs, and income tax payments. Tax Services used $45.9 million moreRAL participation receivables increased over the prior year due to a higher dollar amount of loans in cash for off-season costswhich we purchased participation interests, resulting from increases in the fee charged by the lender, our clients’ average refund size and working capital requirements compared to the six months ended October 31, 2003. Additionally, incomemaximum loan amount allowed by the lender. Income tax payments totaled $316.8$406.6 million during the current year, an increase of $145.9$161.2 million over the prior year, due to a change in a tax accounting method, which resulted in the acceleration of taxable income within our Mortgage Services segment.
Issuance of Common Stock.We issue shares of common stock, in accordance with our stock-based compensation plans, out of treasury shares. Proceeds from the issuance of common stock totaled $53.9$119.9 million and $59.9$111.2 million for the sixnine months ended OctoberJanuary 31, 20042005 and 2003,2004, 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 aour shelf registration statement.statements. The Senior Notes are due on October 30, 2014, and are not redeemable by the bondholders prior to maturity. The proceeds from the notes will bewere used to repay our $250.0 million in 6¾%6-3/4% Senior Notes, which were due on November 1, 2004. The remaining proceeds will bewere used for working capital, capital expenditures, repayment of other debt and other general corporate purposes. The proceeds are included in cash and cash equivalents on the condensed consolidated balance sheet at October 31, 2004.
As of OctoberJanuary 31, 2004,2005, we had commercial paper borrowings of $316.1 million$1.5 billion outstanding. Commercial paper issuance during the six months supportedsupports RAL participations and various other cash requirements including share repurchases, income taxes, annual incentive compensation obligations and other off-season working capital needs.requirements.
Dividends.Dividends paid totaled $70.0$106.4 million and $68.1$103.5 million for the sixnine months ended OctoberJanuary 31, 20042005 and 2003,2004, respectively.
Share Repurchases.On June 9, 2004, our Board of Directors approved an authorization to repurchase 15 million shares. This authorization is in addition to the authorization of 20 million shares on June 11, 2003. During the sixnine months ended OctoberJanuary 31, 2004,2005, we repurchased 11.2 million shares pursuant to these authorizations at an aggregate price of $527.5 million or an average price of $46.98 per share. There are 15.1 million shares remaining under these authorizations at OctoberJanuary 31, 2004.2005. We plan to continue to purchase shares on the open market in accordance with these 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 and other investment opportunities available.
Restricted Cash.We hold certain cash balances that are restricted as to use. Cash and cash equivalents —- restricted totaled $496.8$535.3 million at OctoberJanuary 31, 2004.2005. Investment Services held $454.0$520.0 million of this total segregated in a special reserve account for the exclusive benefit of customers. Investment Services’ restricted cash balance has fallen from $531.6 million at the beginning of fiscal year 2005. Restricted cash of $19.2$15.3 million at OctoberJanuary 31, 20042005 held by Business Services is related to funds held to pay payroll taxes on behalf of its customers. Restricted cash held by Mortgage Services totaled $23.6 million and is held for outstanding commitments to fund mortgage loans.
Segment Cash Flows.A condensed consolidating statement of cash flows by segment for the sixnine months ended OctoberJanuary 31, 20042005 follows. Generally, interest is not charged on intercompany activities between segments.
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(in 000s)
(in 000s) | ||||||||||||||||||||||||||||||||||||||||||||||||
Tax | Mortgage | Business | Investment | Consolidated | ||||||||||||||||||||||||||||||||||||||||||||
Tax | Mortgage | Business | Investment | Consolidated | Services | Services | Services | Services | Corporate | H&R Block | ||||||||||||||||||||||||||||||||||||||
Services | Services | Services | Services | Corporate | H&R Block | |||||||||||||||||||||||||||||||||||||||||||
Cash provided by (used in): | Cash provided by (used in): | |||||||||||||||||||||||||||||||||||||||||||||||
Operations | $ | (297,873 | ) | $ | 41,879 | $ | (16,424 | ) | $ | 25,712 | $ | (428,381 | ) | $ | (675,087 | ) | $ | (1,128,154 | ) | $ | 42,964 | $ | (870 | ) | $ | (52,492 | ) | $ | (446,699 | ) | $ | (1,585,251 | ) | |||||||||||||||
Investing | (15,385 | ) | 50,028 | (9,505 | ) | 13,474 | (13,718 | ) | 24,894 | (77,825 | ) | 62,511 | (23,892 | ) | 13,906 | (22,980 | ) | (48,280 | ) | |||||||||||||||||||||||||||||
Financing | 456 | — | (11,604 | ) | — | 165,461 | 154,313 | — | — | (19,462 | ) | — | 1,157,463 | 1,138,001 | ||||||||||||||||||||||||||||||||||
Net intercompany | 334,241 | (89,134 | ) | 36,920 | 3,260 | (285,287 | ) | — | 1,334,086 | (116,041 | ) | 40,954 | 9,712 | (1,268,711 | ) | — | ||||||||||||||||||||||||||||||||
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.
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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 used $297.9 million$1.1 billion in its first and second quartercurrent nine-month operations to cover off-season costs and working capital requirements. This segment also used $77.8 million in investing activities, primarily related to capital expenditures in connection with our real estate expansion initiative.
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 begin to cash flow. Mortgage Services provided $41.9$43.0 million in cash from operating activities and $50.0$62.5 million in cash from investing activities. Cash flows from investing activities primarily related toconsist of $100.3 million in cash received fromreceipts on residual interests.interests, partially offset by $37.7 million in capital expenditures.
Gains on sales. Gains on sales of mortgage loans and related assets totaled $366.6$565.0 million, with the cash received primarily recorded as operating activities. The percentage of cash proceeds we receive from our capital market transactions, which are included within the gains on sales of mortgage assets, is reconciled below.
(in 000s)
Six months ended October 31, | 2004 | 2003 | |||||||||||||||
(in 000s) | |||||||||||||||||
Nine months ended January 31, | 2005 | 2004 | |||||||||||||||
Cash proceeds: | |||||||||||||||||
Whole loans sold by the Trusts | $ | 398,027 | $ | 298,460 | $ | 544,954 | $ | 529,521 | |||||||||
Residual cash flows from Beneficial Interest in Trusts | 95,211 | 66,223 | 142,783 | 123,834 | |||||||||||||
Loans securitized | 21,620 | 129,617 | 53,181 | 115,041 | |||||||||||||
Gain on derivative instruments | 24,544 | — | |||||||||||||||
514,858 | 494,300 | 765,462 | 768,396 | ||||||||||||||
Non-cash: | |||||||||||||||||
Retained mortgage servicing rights | 58,894 | 48,002 | 94,570 | 64,265 | |||||||||||||
Additions to balance sheet(1) | 15,270 | 1,814 | 16,470 | 63,545 | |||||||||||||
74,164 | 49,816 | 111,040 | 127,810 | ||||||||||||||
Portion of gain on sale related to capital market transactions | 589,022 | 544,116 | 876,502 | 896,206 | |||||||||||||
Other items included in gain on sale: | |||||||||||||||||
Changes in beneficial interest in Trusts | (27,858 | ) | 56,576 | (7,981 | ) | 14,658 | |||||||||||
Impairments to fair value of residual interests | (3,469 | ) | (11,106 | ) | (8,304 | ) | (26,048 | ) | |||||||||
Net change in fair value of rate-lock commitments | (1,930 | ) | 613 | ||||||||||||||
Direct origination expenses, net | (189,117 | ) | (130,244 | ) | |||||||||||||
Net change in fair value of derivative instruments | 4,282 | (4,297 | ) | ||||||||||||||
Direct origination and acquisition expenses, net | (299,549 | ) | (208,315 | ) | |||||||||||||
(222,374 | ) | (84,161 | ) | (311,552 | ) | (224,002 | ) | ||||||||||
Reported gains on sales of mortgage assets | $ | 366,648 | $ | 459,955 | $ | 564,950 | $ | 672,204 | |||||||||
Percent of gain on sale related to capital market transactions received as cash(2) | 87 | % | 91 | % | 87 | % | 86 | % | |||||||||
Warehouse Funding. To finance our prime originations, we utilize an on-balance sheet 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 OctoberJanuary 31, 20042005 and April 30, 2004 the balance outstanding under this facility was $3.6$4.4 million and $4.0 million, respectively.
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To fund our non-prime originations, we utilize five off-balance sheet warehouse Trusts. The facilities used by the Trusts had a total capacity of $8.0$9.0 billion as of OctoberJanuary 31, 2004.2005. The Mortgage Services segment is planning to implement a $3.0 billion on-balance sheet commercial paper conduit program by the end ofduring fiscal year 2005.2006. At that time, we willplan to reduce the warehouse facilities to $7.0 billion. This will bring total available warehouse capacity to approximately $10.0 billion.
We believe the sources of liquidity available to the Mortgage Services segment are sufficient for its needs.
Business Services.Business Services funding requirements are largely related to receivables for completed work and “work in process.” We provide funding sufficient to cover their working capital needs. This segment used $16.4$0.9 million in operating cash flows during the first halfnine months of the year. Business Services also used $23.9 million and $19.5 million in investing and financing activities,
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respectively. Investing activities included acquisitions and capital expenditures, while financing activities consist 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.
At OctoberJanuary 31, 2004,2005, HRBFA’s net capital of $121.2$118.8 million, which was 18.6%18.0% of aggregate debit items, exceeded its minimum required net capital of $13.0$13.2 million by $108.2$105.6 million. During the first half of fiscalcurrent year, 2005, we contributed additional capital of $10.0$17.0 million, even though HRBFA was in excess of the minimum net capital requirement, and we may continue to do so in the future.
In the first halfnine months of fiscal year 2005, Investment Services provided $25.7used $52.5 million fromin its operating activities primarily due to operating losses and the timing of cash deposits that are restricted for the benefit of customers. Cash provided by investing activities consists primarily of proceeds from the sale of branch offices.
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.
Pledged securities at OctoberJanuary 31, 20042005 totaled $48.0$53.5 million, an excess of $5.0$13.2 million over the margin requirement. Pledged securities at the end of fiscal year 2004 totaled $46.3 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.
OFF-BALANCE SHEET FINANCING ARRANGEMENTS
Substantially all non-prime mortgage loans we originate are sold daily to the Trusts. The Trusts purchase the loans from us utilizing five warehouse facilities that were arranged by us. The warehouse facilities were increased to $8.0 billion during the second quarter,us, bear interest at one-month LIBOR plus 50 to 200 basis points and expire on various dates during the year. In December 2004, the warehouse facilities were increased from $8.0 billion to $9.0 billion through February 15, 2005. This increase was pursuant to an amendment to the warehouse facility with Bank of America, N.A. (the BOA Facility) as reported on our current report on Form 8-K dated December 17, 2004, which is incorporated herein by reference.
On February 15, 2005, the BOA Facility was amended further to extend the term through May 15, 2005 of the $1.0 billion in warehouse capacity added in December 2004. The additional $1.0 billion increases our maximum guarantee, which is equal to approximately 10% of the aggregate principal balance of mortgage loans held by the Trusts.
There have been no other material changes in our off-balance sheet financing arrangements from those reported at April 30, 2004 in our Annual Report on Form 10-K.
COMMERCIAL PAPER ISSUANCE
We maintain unsecured CLOCs to support our commercial paper program and for general corporate purposes. During the second quarter, we replaced our $2.0 billion CLOC with two CLOCs. The two CLOCs are from a consortium of thirty-one banks. The first $1.0 billion CLOC is subject to annual renewal in August 2005, has a one-year term-out provision with a maturity date in August 2006 and has an annual facility fee of ten basis points per annum. The second $1.0 billion CLOC has a maturity date of August 2009 and has an annual facility fee of twelve basis points per annum. These lines are subject to various affirmative and negative covenants, including a minimum net worth covenant. These CLOCs are for working capital use, general corporate purposes and commercial paper back up. We obtained an additional $750.0 million line of credit for the period of January 26 to February 25, 2005 to back-up peak commercial paper issuance or use as an alternate source of funding for RAL participations. This line is subject to various covenants, substantially similar to the primary CLOCs. These CLOCs were undrawn at January 31, 2005.
At OctoberJanuary 31, 2004,2005, there was no$25.0 million (Canadian) of commercial paper outstanding under the H&R Block Canada commercial paper program. The Canadian issuances are supported by a credit facility provided by one
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bank in an amount not to exceed $125.0 million (Canadian). The Canadian CLOC is subject to annual renewal in December 2005. The Canadian CLOC was undrawn at January 31, 2005.
There have been no other material changes in our commercial paper program from those reported at April 30, 2004 in our Annual Report on Form 10-K.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
There have been no material changes in our contractual obligations and commercial commitments from those reported at April 30, 2004 in our Annual Report on Form 10-K.
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REGULATORY ENVIRONMENT
There have been no material changes in our regulatory environment from those reported at April 30, 2004 in our Annual Report on Form 10-K.
FORWARD-LOOKING INFORMATION
In this report, and from time to time throughout the year, we share our expectations for our 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.
There have been no material changes in our risk factors from those reported at April 30, 2004 in our Annual Report on Form 10-K.
There have been no material changes in our market risks from those reported at April 30, 2004 in our Annual Report on Form 10-K.
Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934, such as this Form 10-Q, is recorded, processed, summarized and reported in accordance with the SEC’s rule. Disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer or persons performing similar functions, as appropriate, to allow timely decisions regarding disclosure.
Our Disclosure Controls were designed to provide reasonable assurance that the controls and procedures would meet their objectives. Our management, including the CEO and CFO, 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 errors or mistakes. 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.
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As of OctoberJanuary 31, 2004,2005, 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 CEO and CFO.
The evaluation of our Disclosure Controls included a review of the controls’ objectives and design, our implementation of the controls and the effect of the controls on the information generated for use in this Form 10-Q. In our Form 10-K for the year ended April 30, 2004, we reported a series ofvarious control weaknesses related to our corporate tax accounting function. These weaknesses related specifically to the reconciliation and level of detailed support of both current and deferred income tax accounts. We also determined an acceleration of taxable income was warranted in one of our segments, although there was no change to our total income tax provision. Upon identification of these control weaknesses,
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immediate corrective action was undertaken. Remediation that was complete or substantially complete at January 31, 2005 included the following:
• | Two additional tax directors have been added to our corporate tax department. Each has significant federal, state and local tax experience and one director also has tax GAAP experience. Where necessary, we have retained outside experts to supplement our core knowledge of the complexities around mortgage securitizations. These resources, when combined with our existing resources, will enable the department to serve the technical needs of the enterprise. | |||
• | A formal policy governing all key aspects of accounting for income taxes has been developed and adopted. Departmental procedures are being revised to conform to the provisions of the policy. | |||
• | The corporate controller’s department and the corporate tax department are focused on communicating more effectively with an increased concentration on the financial reporting aspects of tax items. | |||
• | The corporate tax department is now an active participant in the quarterly results review meetings with our business segment leaders. During these meetings, leaders engage in a detailed review of quarterly financial statements. | |||
• | Detailed, entity-specific support for all components of deferred taxes is being compiled as of the last audited financial statement date, and will be updated through the most recent calendar year end. |
Our efforts to strengthen financial and internal controls continue. We expect these efforts to be completed by the end of fiscal year 2005.
Based on this evaluation, other than the item described above, our CEO and CFO have concluded these controls are effective. There have been no significant changes in internal controls, or in other factors, which would significantly affect these controls subsequent to the date of evaluation.
PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information below should be read in conjunction with the information included in note 1112 to our condensed consolidated financial statements.
RAL Litigation
We reported in current reports on Form 8-K, previous quarterly reports on Form 10-Q and in our annual report on Form 10-K for the year ended April 30, 2004, certain events and information regarding lawsuits throughout the country regarding our refund anticipation loan programs (collectively, “RAL Cases”). The RAL Cases have involved a variety of legal theories asserted by plaintiffs. These theories include allegations that, among other things,things: disclosures in the RAL applications were inadequate, misleading and untimely,untimely; the RAL interest rates were usurious and unconscionable,unconscionable; we did not disclose that we would receive part of the finance charges paid by the customer for such loans,loans; breach of state laws on credit service organizations,organizations; breach of contract, unjust enrichment, unfair and deceptive acts or practices,practices; violations of the federal Racketeer Influenced and Corrupt Organizations (RICO) Act,Act; violations of the federal Fair Debt Collection Practices ActAct; and that we owe and breached a fiduciary duty to our customers in connection with the RAL program.
The amounts claimed in the RAL Cases have been substantial in some instances. We have successfully defended against numerous RAL Cases, although several of the RAL Cases are still pending. Of these RAL
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Cases that are no longer pending, some 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 were settled, with one settlement resulting in a pretax expense of $43.5 million in fiscal year 2003 (the “Texas RAL Settlement”).
We continue to believe we have meritorious defenses to the RAL Cases, and we intend to defend the remaining RAL Cases vigorously. There can be no assurances, however, as to the outcome of the pending RAL Cases individually or in the aggregate. Furthermore, there can be no assurances regarding the impact of the RAL Cases on our consolidated 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 in which developments occurred during or after the three months ended OctoberJanuary 31, 2004:2005:
Lynne A. Carnegie, et al. v. Household International, Inc., H&R Block, Inc., et 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. On April 15, 2003, the District Court judge declined to approve a $25.0 million nationwide settlement of this matter, under which we and the lending bank would have each paid $12.5 million. The judge’s decision was based on a finding that counsel for the settlement plaintiffs had been inadequate representatives of the plaintiff class and failed to sustain their burden of showing that the settlement was fair. The judge subsequently appointed new counsel for the plaintiffs who filed an amended complaint and a motion for partial summary judgment. On March 29, 2004, the court either dismissed or decertified all of the plaintiffs’ claims other than part of one count alleging violations of the racketeering and conspiracy provisions of the RICO Act. The United States Court of Appeals for the Seventh Circuit subsequently affirmed the trial court’s certification of a nationwide class on the RICO count. The case is scheduled to go to trial in MarchOctober 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. Our Board of Directors approved a proposed settlement of the case on September 8, 2004. During the process of finalizing the settlement agreement, the parties were unable to reach agreement regarding certain settlement terms. We intend to continue defending the case vigorously, but there is no assurance as to its outcome.
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Deandra D. Cummins, et al. V. H&R Block, Inc., et al.,Case No. 03-C-134, in the Circuit Court of Kanawha County, West Virginia. AOn December 30, 2004, the trial court certified a class certification hearing commenced in October 2004 and was continued until December 22, 2004. Aconsisting of all West Virginia residents who obtained RALs from January 1, 1994 to present. On February 23, 2005, the U.S. Supreme Court denied our request to review the West Virginia Supreme Court’s decision on class certification is expected in early 2005, andnot to review the trial court’s denial of our motion to compel arbitration. The case is scheduled to go to trial in October 2005.
Sandra J. Basile, et al. v. H&R Block, Inc. et al.,April Term 1992 Civil Action No. 3246, Court of Common Pleas, First Judicial district of Pennsylvania, Philadelphia County, instituted on April 23, 1993. On February 3, 2005, the Pennsylvania appellate court granted plaintiff’s motion foren bancreview of the appellate court’s previous three-judge panel decision denying plaintiff’s appeal of the trial court class decertification. Re-argument is expected to occur in June 2005.
Peace of Mind Litigation
Lorie J. Marshall, et al. v. H&R Block Tax Services, Inc., et al., Civil Action 2002L000004, in the Circuit Court of Madison County, Illinois, is a class action case filed on January 18, 2002, as to which the court granted plaintiffs’ first amended motion for class certification on August 27, 2003. Plaintiffs’ claims consist of five counts relating to the defendants’ Peace of Mind program under which the applicable tax return preparation subsidiary assumes liability for the cost of additional tax assessments attributable to tax return preparation error. The plaintiffs allege that defendants’ sale of its Peace of Mind guarantee constitutes statutory fraud by selling insurance without a license, an unfair trade practice by omission and by “cramming” (i.e., charging customers for the guarantee even though they did not request it and/or did not want it), and constitutes a breach of fiduciary duty. In August 2003, the court certified the following plaintiff classes: (1) all persons who were charged a separate fee for Peace of Mind by “H&R Block” or a defendant H&R Block class member from January 1, 1997 to final judgment; (2) all persons who reside in certain class states and who were charged a separate fee for Peace of Mind by “H&R Block,” or a defendant H&R Block class member, and that was not licensed to sell insurance, from January 1, 1997 to final judgment; and (3) all persons who had an unsolicited charge for Peace of Mind posted to their bills by “H&R Block”Block,” or a defendant H&R Block class member from January 1, 1997, to final judgment. Among those excluded from the plaintiff classes are all persons who received the Peace of Mind guarantee through an H&R Block Premium office and all persons who reside in Texas and Alabama. The court also certified a defendant class consisting of any entity with the names “H&R Block” or “HRB”
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in its name, or otherwise affiliated or associated with H&R Block Tax Services, Inc., and which sold or sells the Peace of Mind product. The trial court subsequently denied the defendants’ motion asking the trial court to certify the 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 Mind guarantee. This case is being tried before the same judge that presided over the Texas RAL Settlement and involves the same plaintiffs attorneys that are involved in the Marshall litigation in Illinois and substantially similar allegations. No class has been certified in this case.
We believe the claims in these Peace of Mind actions are without merit and we intend to defend them vigorously. However, there can be no assurances as to the outcome of these pending actions individually or in the aggregate, and there can be no assurances on the impact of these actions on our consolidated results of operations or financial position.statements.
Other Claims and Litigation
As with other broker-dealers, HRBFA has been the subject of an investigation by the National Association of Securities Dealers, Inc. (NASD) regarding the market timing of mutual funds. The investigation concernsconcerned the trading activity by two former financial advisors, primarily on behalf of one of HRBFA’s institutional clients. HRBFA has cooperatedAfter substantive discussions with the NASD, and has had substantiveHRBFA agreed to a settlement discussions. While these discussions have not concluded, we anticipate thatof the matter, will be resolved in the near future, although we cannot provide assurance regarding the ultimate resolutionwithout admitting or denying any wrongdoing. We paid a fine of this matter, we believe the resolution will not have a material adverse effect on our operations, consolidated results of operations or financial position.$500,000 and $325,000 restitution, to mutual fund customers.
As reported in a current report on Form 8-K dated November 8, 2004, the NASD brought charges against HRBFA related to the sale by HRBFA of Enron debentures in 2001. ATwo private civil actionactions subsequently waswere filed against HRBFA concerning the matter raised in the NASD’s charges.charges, one of which was subsequently dismissed without prejudice. We intend to defend the charges and the civil suit vigorously. There can be no assurances as to the outcome and resolution of this matter.
As part of an industry-wide review, the Internal Revenue Service (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 registration and listing regulations and whether such strategies were appropriate. If the IRS were to determine that these
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strategies were inappropriate, clients that utilized the strategies could face penalties and interest for underpayment of taxes and may attempt to seek recovery from RSM. There can be no assurances as to the outcome of this matter.
As reported in current report on Form 8-K dated December 12, 2003, the United States SEC informed outside counsel to the Company on December 11, 2003 that the Commission had issued a Formal Order of Investigation concerning our disclosures, in and before November 2002, regarding RAL litigation to which we were and are a party. There can be no assurances as to the outcome and resolution of this matter.
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 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. Some of these claims and lawsuits pertain to RALs, the electronic filing of customers’ income tax returns and the Peace of Mind guarantee program. OthersWe 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 the Express IRA program andinvestment products, the preparation of customers’ income tax returns, the electronic filing of customers’ tax returns, the fees charged customers for various products and services, losses incurred by customers with respect to their investment accounts, relationships with franchisees, denials of mortgage loans, contested mortgage foreclosures, other aspects of the mortgage business, intellectual property disputes, 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
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settlements in these other mattersOther Claims will not have a material adverse effect on our consolidated results of operations or financial position.statements.
ITEM 2. CHANGES INUNREGISTERED SALES OF EQUITY SECURITIES AND USES OF PROCEEDS
A summary of our purchases of H&R Block common stock during the secondthird quarter of fiscal year 2005 is as follows:
(shares in 000s)
Total Number of Shares | Maximum Number | |||||||||||||||
Total | Average | Purchased as Part of | of Shares that May | |||||||||||||
Number of Shares | Price Paid | Publicly Announced | Be Purchased Under | |||||||||||||
Purchased(1) | per Share | Plans or Programs(2) | the Plans or Programs(2) | |||||||||||||
August 1 – August 31 | 1,484 | $ | 48.60 | 1,484 | 17,430 | |||||||||||
September 1 – September 30 | 1,375 | $ | 48.16 | 1,374 | 16,056 | |||||||||||
October 1 – October 31 | 952 | $ | 46.06 | 952 | 15,104 |
(shares in 000s) | ||||||||||||||||
Total Number of Shares | Maximum Number | |||||||||||||||
Total | Average | Purchased as Part of | of Shares that May | |||||||||||||
Number of Shares | Price Paid | Publicly Announced | Be Purchased Under | |||||||||||||
Purchased(1) | per Share | Plans or Programs(2) | the Plans or Programs(2) | |||||||||||||
November 1 – November 30 | 2 | $ | 49.22 | — | 15,104 | |||||||||||
December 1 – December 31 | — | $ | 48.08 | — | 15,104 | |||||||||||
January 1 – January 31 | 4 | $ | 47.40 | — | 15,104 | |||||||||||
(1) |
(2) | On June 11, 2003 and June 9, 2004, our Board of Directors approved the repurchase of 20 million shares and 15 million shares, respectively, of H&R Block, Inc. common stock. These authorizations have no expiration dates. |
Our Articles of Incorporation were amended on September 30, 2004 to increase the number of authorized shares of common stock, without par value, from 500,000,000 shares to 800,000,000 shares. The aggregate number of shares of all classes of stock that we now have authority to issue is 806,000,000, with 800,000,000 authorized shares of common stock and 6,000,000 authorized shares of a class designated preferred stock, without par value. The amendment to the Articles of Incorporation was approved by our shareholders at the annual meeting of shareholders held on September 8, 2004. The Certificate of Amendment is filed as Exhibit 3.1 to this Form 10-Q, and the Restated Articles of Incorporation, incorporating all amendments thereto, are filed as Exhibit 3.2 to this Form 10-Q.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSThe annual meeting of shareholders of the registrant was held on September 8, 2004. At such meeting, three Class III directors were elected to serve three-year terms. In addition, the proposals set forth below were submitted to a vote of shareholders. With respect to the election of directors and the adoption of each
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proposal, the number of votes cast for, against or withheld, the number of abstentions, and the number of no votes (if applicable) were as follows:
Election of Class III Directors: | ||||||||
Nominee | Votes FOR | Votes WITHHELD | ||||||
Donna R. Ecton | 143,089,287 | 3,003,702 | ||||||
Louis W. Smith | 143,702,345 | 2,390,644 | ||||||
Rayford Wilkins, Jr. | 133,272,098 | 12,820,891 |
Approval of an Amendment to the Company’s Articles of Incorporation to increase the number of shares of Common Stock from 500,000,000 to 800,000,0006. EXHIBITS
Termination Agreement dated January 7, 2005, between H&R Block, Inc., H&R Block Financial Advisors, Inc. and Brian L. Nygaard. | ||||
Approval of an Amendment to the 1989 Stock Option Plan for Outside Directors to extend the plan for five years, such that it will terminate, unless further extended, on December 5, 2009
Approval of an Amendment to the 1999 Stock Option Plan for Seasonal Employees to (i) extend the Plan for two years, such that it will terminate, unless further extended, on December 31, 2006 and (ii) increase the aggregate number of authorized shares of Common Stock issuable under the Plan from 20,000,000 to 23,000,000
Ratification of the Appointment of KPMG LLP as the Registrant’s Independent Accountants for the year ended April 30, 2005
At the close of business on June 30, 2004, the record date for the annual meeting of shareholders, there were 167,770,955 shares of Common Stock of the registrant outstanding and entitled to vote at the meeting. There were 146,092,989 shares represented at the annual meeting of shareholders held on September 8, 2004.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
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10.2 | ||||
10.3 | ||||
Option One Mortgage Corporation. | ||||
10.4 | 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. | |||
10.5 | ||||
10.6 | 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. | |||
10.7 | Indenture dated as of November 1, 2003 between Option One Owner Trust 2003-5 and Wells Fargo Bank Minnesota, National Association. | |||
10.8 | Amended and Restated Sale and Servicing Agreement dated as of November 25, 2003 among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank Minnesota, National Association. | |||
10.9 | Amendment Number One to the Amended and Restated Sale and Servicing Agreement, dated as of April 30, 2004, among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank Minnesota, National Association. | |||
10.10 | Amendment Number Two to the Amended and Restated Sale and Servicing Agreement, dated as of December 17, 2004, among Option One Owner Trust 2001-2, Option One Loan Warehouse Corporation, Option One Mortgage Corporation and Wells Fargo Bank N.A. | |||
10.11 | 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. | |||
10.12 | 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. |
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10.13 | 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. | |||
10.14 | Amended and Restated Indenture dated as of November 25, 2003 between Option One Owner Trust 2001-2 and Wells Fargo Bank Minnesota, National Association. | |||
10.15 | Letter Agreement dated as of April 1, 2000 among Option One Mortgage Corporation, Bank of America, N.A. | |||
31.1 | Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
31.2 | Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
32.1 | Certification by Chief Executive Officer furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002. | |||
32.2 | Certification by Chief Financial Officer furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002. | |||
b) Reports on Form 8-K
The registrant filed current reports on Form 8-K and Form 8-K/A, each dated August 24, 2004, reporting under Item 2.02 thereof its issuance of a press release announcing the results of operations for its first quarter ending July 31, 2004.
The registrant filed current reports on Form 8-K and Form 8-K/A, each dated September 9, 2004, reporting under Item 1.01 and/or Item 5.02 thereof its appointment of a Chief Financial Officer.
The registrant filed a current report on Form 8-K dated October 18, 2004, reporting under Items 5.02 and 9.01 thereof its issuance of a press release announcing the election of a new member to its Board of Directors.
The registrant filed a current report on Form 8-K dated October 21, 2004, reporting under Items 1.01, 8.01 and 9.01 thereof its entry into an underwriting agreement in connection with its debt offering.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
H&R BLOCK, INC. | ||||
(Registrant) | ||||
DATE | BY | /s/ Mark A. Ernst | ||
Mark A. Ernst | ||||
Chairman of the Board, President | ||||
and Chief Executive Officer | ||||
DATE | BY | /s/ William L. Trubeck | ||
William L. Trubeck | ||||
Executive Vice President and | ||||
Chief Financial Officer |
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