Improved Off-Season Results From Continuing Operations; Discussions Under Way With Cerberus In Effort To Modify Option One Sale Transaction; FY08 Earnings Guidance Updated To $1.30 To $1.45 Per Share From Continuing Operations
H&R Block Inc. today (August 30) reported that revenues from continuing operations rose 11 percent and operating results from continuing operations improved in its fiscal 2008 first quarter compared with the same period last year. The company normally reports a first-quarter operating loss primarily because of seasonality within its Tax Services and Business Services segments.
Revenues from continuing operations in H&R Block’s fiscal first quarter ended July 31 rose to $381.2 million from $342.8 million in last year's quarter. Net loss from continuing operations of $109.8 million, or 34 cents a share, was 7 percent better than a $117.8 million loss, or 36 cents a share, in the prior-year period.
“Each of our continuing businesses performed in line with our expectations during the quarter,” said Mark A. Ernst, chairman and chief executive officer. “In the tax business, we've been investing as planned in initiatives to drive enhanced client service for the coming tax season, leveraging the unique products we can offer clients through H&R Block Bank.
“In Consumer Financial Services, solid growth at both the bank and H&R Block Financial Advisors combined to deliver a great quarter,” Ernst continued, “and RSM McGladrey is beginning to realize the full benefits of integrating our American Express Tax and Business Services acquisition.”
H&R Block also announced today that it is engaged in discussions with Cerberus Capital Management, L.P. in an effort to modify the agreement H&R Block entered into in April to sell Option One Mortgage Corp. to Cerberus. Certain closing conditions of this agreement currently are not being met. Consequently, some of the key components of the discussions currently are:
The closing conditions requiring Option One to have $2 billion in loans funded within 60 days of closing and $8 billion minimum in warehouse lines would be waived, with certain other closing conditions being waived or modified.
H&R Block would be responsible for divesting or winding down Option One's remaining origination business, which would be pursued immediately. As a result, certain shutdown costs may be incurred.
Cerberus would purchase Option One's loan servicing platform.
The parties are working toward advancing the Dec. 31 contract termination date to provide for an earlier resolution of the Option One situation.
Other sections of the contract may also be changed or eliminated. While H&R Block hopes to conclude these negotiations soon, the company cannot be sure that it will be able to do so. If the parties are unable to reach agreement on the modifications, the existing agreement remains in effect with its original terms, though there can be no assurance it will close. Until the ongoing discussions are concluded, H&R Block will not have any further comment.
Results of the Option One business, H&R Block Mortgage Corp. and two small non-mortgage businesses are reported as discontinued operations. Net loss from discontinued operations was $192.8 million, or 59 cents per share, for the fiscal 2008 first quarter, versus a loss of $13.5 million, or 5 cents per share, in last year’s period.
Including discontinued operations, H&R Block's consolidated net loss for the fiscal 2008 first quarter was $302.6 million, or 93 cents per share, versus $131.4 million, or 41 cents per share, a year ago.
Fiscal 2008 Outlook
“We took major steps last year to simplify the company’s business mix and sharpen our focus on our tax, accounting and related financial services businesses,” Ernst said. “Based on first quarter results for our continuing operations, fiscal 2008 is off to a good start.”
The company has updated its range of expected earnings from continuing operations for fiscal 2008 to $1.30 to $1.45 per share, narrowing it from the prior expectation of $1.25 to $1.45 per share. Earnings from continuing operations were $1.15 per share in fiscal 2007.
The change reflects finalized product designs and strategies for the Tax Services segment, in which the company anticipates a good season in retail tax complemented by further gains in digital tax services. The outlook also includes a doubling or more of profits in Consumer Financial Services, driven by continued bank expansion and further profit gains by H&R Block Financial Advisors. The company expects solid performance as well in RSM McGladrey’s core accounting, tax and consulting services. Results of discontinued operations will continue to have a negative impact on consolidated earnings into the second, and possibly third, quarter of the fiscal year.
Tax Services
First quarter Tax Services revenues rose 6 percent to $69.9 million from $65.7 million. The segment had a pretax loss of $172.3 million compared with a $153.1 million loss last year.
The fiscal 2008 quarterly loss reflects off-season expenses associated with expansion into the company’s commercial tax markets business and the recent acquisition of previously franchised operations in Las Vegas, investments in technology infrastructure and a slight increase in normal operating expenses.
In an effort to better serve clients who file in the critical early part of the tax season, the company has joined with leading refund lenders to dramatically lower the cost of refund anticipation loans. The loan product will be offered nationally through both H&R Block retail tax offices and professional preparers who use TaxWorks or 1040Works (commercial tax preparation software platforms H&R Block acquired last fiscal year).
“We are intently focused on competing professionally, yet aggressively, for early season filers,” Ernst stated.
Consumer Financial Services
First quarter 2008 revenues from continuing operations of $114.4 million were 45 percent above the $78.8 million recorded in the prior year quarter, reflecting planned growth of H&R Block Bank and continued profitability improvements by H&R Block Financial Advisors (HRBFA). Segment pretax income from continuing operations rose to $6.2 million, more than $9 million better than a loss of $3.1 million a year ago.
“Our bank started its second year of operation with a strong quarter, and we’re still in the early stages of realizing its potential for competitive advantage,” Ernst said.
“Beyond the Bank’s own contribution to earnings, we look forward to realizing the tax client retention opportunity created by the popularity of the H&R Block Prepaid Emerald MasterCard®,” he said. Issued by the bank, the Emerald Card was selected by an unprecedented 2 million tax clients last season, enabling them to receive refund-related funds at tax time and to access consumer banking services year-round.
“Yesterday we announced a bank product that builds on this highly successful launch,” Ernst continued. “It links the card to a year-round line of credit that offers tax clients a low fixed annual percentage rate when they link it to a high-yield savings account also offered by the bank. This new product will provide credit when clients need it in a way that builds loyalty for our tax business.”
HRBFA again achieved profitability in the quarter. Results benefited from higher advisor productivity, which was driven by organic business growth and recruiting success. “These improved results reflect operating changes management has made in the business over the past two years,” Ernst said, “and we are on track for ongoing earnings contributions.”
Business Services
Business Services had a strong quarter, experiencing good organic growth despite a slight decline in reported revenues. Revenues for the fiscal 2008 first quarter were down 1 percent to $192.8 million from $195.5 million. This was primarily due to reduced capital markets revenue, reflecting a decision to phase out business valuation services and focus solely on capital market transaction advisory services.
In addition to 9 percent revenue growth in its tax business, the segment also achieved meaningful improvement versus prior year in its off-season loss. The loss was reduced to $1.9 million from $7.0 million in the year-ago quarter, due primarily to efficiencies resulting from the integration of American Express Tax and Business Services.
Investment continued during the quarter in a brand-building initiative designed to drive new business opportunities through greater awareness of RSM McGladrey’s name and business capabilities.
Discontinued Operations
May and June improvements in the mortgage market environment were reversed in July after rating agency changes in loan collateral guidelines. These changes lowered the value of loans held in warehouses throughout the industry, made certain loan products unprofitable, and lowered the value of virtually all non-prime originations. Option One responded to these issues with changes to its products and programs, including rate increases, and actions to reduce asset values to recognize overall market illiquidity.
The pretax loss noted earlier reflects a $57.4 million loss on sale, $157.3 million in loan loss and repurchase reserves and a $49.6 million impairment of residual interests.
Cost of origination was 262 basis points, up from 245 basis points in the fiscal 2007 fourth quarter. Based on loan executions of $3.1 billion in the fiscal 2008 first quarter, the business incurred losses from origination activities leading to a 586 basis points net loss on sale gross margin for the quarter.
Option One has significantly tightened its underwriting criteria so that loans originated result in clear access to the available secondary market and limit the company’s ongoing capital commitment.
“Given the unprecedented disruption in the credit markets, in August we took action to limit any more exposure to non-prime mortgage originations by stopping all but Fannie Mae and Freddie Mac-eligible loans,” Ernst said.
Option One also dramatically scaled back its loan commitment activity to a level that should result in an originations run rate of approximately $200 million per month by mid-September. The company has continued to restructure its origination platform to align resources with substantially lower volume.
To the extent that market conditions fail to improve, the company estimates that the mortgage business may continue to incur significant pretax impairments of approximately $150 million to $200 million to existing residuals, beneficial interests in trusts and loans held for sale.
Other
Corporate and eliminations pretax loss decreased to $15.6 million in the 2008 first quarter from $30.9 million, reflecting improved borrowing rates, lower legal expenses and $4.2 million of additional investment income.
During the first quarter, the company issued 1.6 million treasury shares for option exercises, share purchases under the employee stock purchase plan and vesting of restricted share grants.
Given the first quarter loss within discontinued operations and estimated losses during the second and potentially third quarters, the company now expects that it will not be able to repurchase shares for treasury until some time in fiscal 2009. -H&R Blocks inc.
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