UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One) | ||
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended April 30, 2015 | ||
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.
(Exact name of registrant as specified in its charter)
MISSOURI | 44-0607856 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
One H&R Block Way, Kansas City, Missouri 64105
(Address of principal executive offices, including zip code)
(816) 854-3000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, without par value | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, without par value
(Title of Class)
Indicate by check mark whether the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
The aggregate market value of the registrant's Common Stock (all voting stock) held by non-affiliates of the registrant, computed by reference to the price at which the stock was sold on October 31, 2014, was $8,829,034,967.
Number of shares of the registrant's Common Stock, without par value, outstanding on May 31, 2015: 275,286,996.
Documents incorporated by reference
The definitive proxy statement for the registrant's Annual Meeting of Shareholders, to be held September 10, 2015, is incorporated by reference in Parts II and III to the extent described therein.
2015 FORM 10-K AND ANNUAL REPORT
TABLE OF CONTENTS
INTRODUCTION AND FORWARD-LOOKING STATEMENTS | ||
ITEM 1. | BUSINESS | |
ITEM 1A. | RISK FACTORS | |
ITEM 1B. | UNRESOLVED STAFF COMMENTS | |
ITEM 2. | PROPERTIES | |
ITEM 3. | LEGAL PROCEEDINGS | |
ITEM 4. | MINE SAFETY DISCLOSURES | |
ITEM 5. | MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES | |
ITEM 6. | SELECTED FINANCIAL DATA | |
ITEM 7. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | |
ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | |
ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | |
ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | |
ITEM 9A. | CONTROLS AND PROCEDURES | |
ITEM 9B. | OTHER INFORMATION | |
ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE | |
ITEM 11. | EXECUTIVE COMPENSATION | |
ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | |
ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE | |
ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES | |
ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES | |
SIGNATURES | ||
EXHIBIT INDEX | ||
INTRODUCTION
"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.
Specified portions of our proxy statement are "incorporated by reference" in response to certain items. Our proxy statement will be made available to shareholders in July 2015, and will also be available on our website at www.hrblock.com.
FORWARD-LOOKING STATEMENTS
This report and other documents filed with the Securities and Exchange Commission (SEC) may contain forward-looking statements. In addition, our senior management may make forward-looking statements orally to analysts, investors, the media and others. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words or variation of words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," "projects," "forecasts," "targets," "would," "will," "should," "could," "may" or other similar expressions. Forward-looking statements provide management's current expectations or predictions of future conditions, events or results. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future are forward-looking statements. They may include estimates of revenues, income, earnings per share, capital expenditures, dividends, stock repurchase, liquidity, capital structure or other financial items, descriptions of management's plans or objectives for future operations, services or products, or descriptions of assumptions underlying any of the above. All forward-looking statements speak only as of the date they are made and reflect the Company's good faith beliefs, assumptions and expectations, but they are not guarantees of future performance or events. Furthermore, the Company disclaims any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions, factors, or expectations, new information, data or methods, future events or other changes, except as required by law.
By their nature, forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. Factors that might cause such differences include, but are not limited to, a variety of economic, competitive, operational and regulatory factors, many of which are beyond the Company's control. Investors should understand that it is not possible to predict or identify all such factors and, consequently, should not consider any such list to be a complete set of all potential risks or uncertainties.
Details about risks, uncertainties and assumptions that could affect various aspects of our business are included throughout this Form 10-K. Investors should carefully consider all of these risks, and should pay particular attention to Item 1A, "Risk Factors," and Item 7 under "Critical Accounting Policies" of this Form 10-K.
PART I
ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
H&R Block, Inc. was organized as a corporation in 1955 under the laws of the State of Missouri and has subsidiaries that provide tax preparation, banking and other services. A complete list of our subsidiaries can be found in Exhibit 21.
Our Tax Services segment provides assisted income tax return preparation, digital do-it-yourself (DIY) tax solutions and other services and products related to income tax return preparation to the general public primarily in the United States (U.S.) and its territories, Canada and Australia. This segment also offers retail banking services in the U.S. through H&R Block Bank (HRB Bank), a federal savings bank.
RECENT DEVELOPMENTS – In April 2014, our subsidiaries, HRB Bank and Block Financial LLC, the sole shareholder of HRB Bank (Block Financial), entered into a definitive Purchase and Assumption Agreement (P&A Agreement) with BofI Federal Bank, a federal savings bank (BofI). The P&A Agreement is subject to various closing conditions, including the receipt of certain required approvals, entry into certain additional agreements, and the fulfillment of various other customary conditions. If the closing conditions (including regulatory approvals) are satisfied, we will complete a transaction in which we will sell assets and assign certain liabilities, including all of HRB Bank's deposit liabilities, to BofI (P&A Transaction). As previously disclosed, the parties to the P&A Agreement entered into a Letter Agreement, effective October 23, 2014 (October Letter Agreement), which, among other things, extended the date after which
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any party is permitted to terminate the P&A Agreement from October 31, 2014 to May 31, 2015. The October Letter Agreement was filed as an exhibit to our Current Report on Form 8-K on October 23, 2014. The parties to the P&A Agreement entered into another Letter Agreement, effective February 12, 2015 (February Letter Agreement), which, among other things, extended the date after which any party is permitted to terminate the P&A Agreement from May 31, 2015 to July 31, 2015 and set the date of closing as June 30, 2015, unless otherwise agreed by the parties. The February Letter Agreement was filed as an exhibit to our Current Report on Form 8-K on February 13, 2015.
Due to the lack of regulatory approval, we continued to offer financial services products to our clients through HRB Bank during the 2015 tax season.
Upon the closing of the P&A Transaction, we will make a cash payment to BofI for the difference in the carrying value of assets sold and the carrying value of liabilities (including deposit liabilities) transferred. The amount of the cash payment made at closing will primarily be equal to the carrying value of the liabilities to be transferred since the carrying value of the assets to be transferred is immaterial. Pursuant to the February Letter Agreement, the parties have set the date of closing as June 30, 2015, unless otherwise agreed by the parties. As of the date of this filing, the parties have not received formal regulatory approval and, as a result, the parties do not expect to close the P&A Transaction on the previously contemplated June 30, 2015 date. Due to the seasonality of our business, the timing of any closing of the P&A Transaction will impact the amount of deposit liabilities transferred.
In connection with the additional agreements expected to be entered into upon the closing of the P&A Transaction, BofI will offer H&R Block-branded financial products distributed by the Company to the Company's clients. An operating subsidiary of the Company will provide certain marketing, servicing and operational support to BofI with respect to such financial products.
The P&A Transaction is part of a three-step transaction pursuant to which the Company plans to divest HRB Bank (Divestiture Transaction), including: (1) the conversion of HRB Bank from a federal savings bank to a national bank; (2) the sale of certain HRB Bank assets to and assignment of certain liabilities (including all deposit liabilities) to BofI in the P&A Transaction; and (3) the merger of HRB Bank with and into Block Financial.
H&R Block, Inc., H&R Block Group, Inc. and Block Financial (our Holding Companies) are savings and loan holding companies (SLHCs) because they control HRB Bank. By consummating the Divestiture Transaction, our Holding Companies will cease to be SLHCs and will no longer be subject to regulation by the Board of Governors of the Federal Reserve System (Federal Reserve) as SLHCs or to the regulatory capital requirements applicable to SLHCs.
The obligations of the parties to complete the P&A Transaction are subject to the fulfillment of numerous conditions, including regulatory approval. We cannot be certain when or if the conditions to and other components of the P&A Transaction will be satisfied, or whether the P&A Transaction will be completed. In addition, there may be changes to the terms and conditions of the P&A Agreement and other contemplated agreements prior to any closing.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
See discussion below and in Item 8, note 20 to the consolidated financial statements.
DESCRIPTION OF BUSINESS
TAX SERVICES
GENERAL – We provide assisted and DIY tax return preparation - in-person, online, desktop software and mobile applications - and related services to the general public primarily in the U.S. and its territories, Canada, and Australia. Major revenue sources include fees earned for tax preparation and related services performed at company-owned retail tax offices, royalties from franchisees, sales of desktop tax preparation software, fees for online tax preparation services and fees from complementary services. HRB Bank also offers retail banking services, primarily in support of the U.S. tax business.
The Affordable Care Act (ACA) requires nearly everyone in the U.S. to have health insurance or face potential tax penalties. Our tax professionals discuss with clients the exemptions and penalties to help them understand how their taxes may be impacted, see if they qualify for additional credits and complete the additional forms required.
Tax Returns Prepared. During fiscal year 2015, 24.2 million tax returns were prepared by and through H&R Block worldwide, essentially flat compared to 2014, and down from 24.9 million tax returns in 2013. The decline in returns
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between fiscal year 2013 and 2014 is primarily due to discontinuation of our free Federal 1040EZ promotion in virtually all markets. In the U.S., 20.6 million tax returns were prepared by and through H&R Block during fiscal year 2015, compared to 20.8 million in 2014 and 21.6 million in 2013. Our U.S. tax returns prepared during the 2015 tax season, including those prepared by our franchisees and those prepared and filed at no charge, constituted approximately 15% of an Internal Revenue Service (IRS) estimate of total individual income tax returns filed during the 2015 tax season. See Item 7, under "Tax Services," for further discussion of changes in the number of tax returns prepared.
ASSISTED – Assisted income tax return preparation and related services are provided by tax professionals via a system of retail offices operated directly by us or our franchisees.
Offices. During the 2015 tax season, we, together with our franchisees, operated in 10,286 offices across the U.S. at the peak of the tax season, compared to 10,378 in the prior year. A summary of our company-owned and franchise offices is included in Item 7, under "Tax Services – Operating Statistics."
Franchises. We offer franchises as a way to expand our presence in certain markets. Our franchise arrangements provide us with certain rights designed to protect our brand. Most of our franchisees receive, among other things, the right to use our trademark and software, access to product offerings and expertise, signs, specialized forms, advertising and initial training and advisory services. Our franchisees pay us approximately 30% of gross tax return preparation and related service revenues as a franchise royalty in the U.S. Our franchise arrangements typically include a ten year term and do not provide for automatic renewal.
From time to time, we have sold certain company-owned offices to existing franchisees or have acquired the assets of existing franchisees and other tax return preparation businesses, and may continue to do so if future conditions warrant and satisfactory terms can be negotiated.
DO-IT-YOURSELF – In addition to our retail offices, we offer a number of DIY tax preparation alternatives. By offering professional assisted and DIY tax preparation options through multiple channels, we seek to serve our clients in the manner they choose to be served.
Online Tax Services. We offer a comprehensive range of online tax services, from tax advice to complete professional and DIY tax return preparation and electronic filing, through our website at www.hrblock.com. Services available at this website allow clients to prepare their federal and state income tax returns using our online tax program, access tax tips, advice and tax-related news, and use calculators for tax planning. We are a member of Free File, Inc., also referred to as the Free File Alliance (FFA). This alliance was created by the tax return preparation industry and the IRS, and allows qualified filers with an adjusted gross income of $60,000 or less to prepare and file their federal return online at no charge. We believe this program provides a valuable public service and increases our visibility with new clients, while also providing an opportunity to offer our state online tax services to these clients.
Desktop Software. We develop and market DIY desktop income tax preparation software. Our desktop software offers a simple step-by-step tax preparation interview, data imports from money management software, calculations, completion of the appropriate tax forms, error checking and electronic filing. Our desktop software may be purchased online, through third-party retail stores or via direct mail.
Mobile Applications. We develop and offer applications for mobile devices which provide tax and related services to clients, including online tax preparation and tools that complement our other tax preparation services and products.
OTHER OFFERINGS – In addition to our tax services, we also offer clients a number of additional services, including refund transfers that include a fee deduction feature (RTs), H&R Block Emerald Advance® lines of credit (EAs), H&R Block Emerald Prepaid MasterCard®, our Peace of Mind® Extended Service Plan (POM), Tax Identity ShieldSM (TIS), and, for our Canadian clients, a refund discount (Cash Back®) program.
Refund Transfers. RTs, formerly known as refund anticipation checks (RACs), allow clients to receive their tax refunds by their chosen method of disbursement and include a feature allowing clients to deduct tax preparation and service fees from their tax refunds. Clients may choose to receive their RT proceeds by direct deposit to a deposit account, by deposit to their H&R Block Emerald Prepaid MasterCard® or by receiving a check. RTs are available to U.S. clients and are frequently obtained by those who (1) do not have bank accounts into which the IRS can direct deposit their refunds; (2) like the convenience and benefits of a temporary account for receipt of their refund; or (3) prefer to have their tax preparation fees paid directly out of their refunds. In fiscal year 2015, we also began offering a similar program to our Canadian clients, under our Pay With RefundTM program.
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H&R Block Emerald Advance® Lines of Credit. EAs are unsecured lines of credit offered to clients in our offices typically from late November through mid-January, currently in an amount not to exceed $1,000. If the borrower meets certain criteria as agreed in the loan terms, the line of credit can be utilized year-round. Borrowers have the option to pay down balances on EAs with their tax refunds.
H&R Block Emerald Prepaid Mastercard®. The H&R Block Emerald Prepaid MasterCard® allows clients to receive their tax refunds from the IRS directly on a prepaid debit card, or to direct RT proceeds to the card. The card can be used for everyday purchases, bill payments and ATM withdrawals anywhere MasterCard® is accepted. Additional funds can be added to the card year-round through direct deposit or at participating retail locations.
Peace of Mind® Extended Service Plan. In addition to our standard guarantee, we offer POM to U.S. clients, whereby we (1) represent our clients if they are audited by the IRS, and (2) assume the cost, subject to certain limits, of additional taxes owed by a client resulting from errors attributable to H&R Block. The additional taxes paid under POM have a cumulative limit of $5,500 with respect to the federal, state and local tax returns we prepared for applicable clients during the taxable year protected by POM.
Tax Identity ShieldSM. This service program offers clients assistance obtaining an IRS Identity Protection PIN, when eligible, to better protect against unauthorized third parties filing a fraudulent tax return with their information. TIS also includes a pre-tax season identity theft risk assessment and alert, notification if their information is detected on a tax return filed through H&R Block and access to services to help restore their tax identity if necessary.
Cash Back® Refund Discount Program. During the tax season, our Canadian operations advance refunds due to certain clients from the Canada Revenue Agency (CRA), for a fee. The fee charged for this service is mandated by federal legislation which is administered by the CRA. The client assigns to us the full amount of the tax refund to be issued by the CRA and the refund amount is then sent by the CRA directly to us. The number of returns discounted under the Cash Back® program in fiscal year 2015 was 553 thousand, compared to 583 thousand in 2014 and 620 thousand in 2013.
SEASONALITY OF BUSINESS – Because most of our clients file their tax returns during the period from January through April of each year, substantially all of our revenues from income tax return preparation and related services and products are earned during this period. As a result, we generally operate at a loss through a majority of the fiscal year.
HRB Bank's operating results are subject to seasonal fluctuations primarily related to the offering of the H&R Block Emerald Prepaid MasterCard®, EAs and RTs, and therefore peak in February and taper off through the remainder of the tax season.
COMPETITIVE CONDITIONS – We provide both assisted and DIY tax preparation services and products and face substantial competition in and across each category. There are a substantial number of tax return preparation firms and accounting firms offering tax return preparation services, and we face significant competition from independent tax preparers and certified public accountants. Many tax return preparation firms are involved in providing electronic filing services and RTs or similar services to the public. Commercial tax return preparers are highly competitive with regard to price and service, and many firms offer services that may include preparation of tax returns at no charge. Our assisted tax preparation business also faces competition from firms offering DIY tax preparation services and products. In terms of the number of offices and personal tax returns prepared and electronically filed in offices, online and via our desktop software, we are one of the largest single providers of tax return preparation solutions and electronic filing services in the U.S. We also believe we operate the largest tax return preparation businesses in Canada and Australia.
Our DIY tax preparation options include various forms of digital electronic assistance, including online, mobile and desktop software. Many other companies offer digital and online tax preparation services, including Intuit, Inc., our largest competitor offering such services. Like all tax return preparation services and products, price and marketing competition for digital tax preparation services is intense among value and premium products and many firms offer digital services and products at no charge. Our DIY tax solutions services and products also compete with in-office tax preparation services. U.S. federal and certain state and foreign taxing authorities also currently offer, or facilitate the offering of, tax return preparation and filing options to taxpayers at no charge.
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HRB Bank provides banking services primarily to our assisted and DIY tax clients and for many of these clients, HRB Bank is their only provider of banking services. HRB Bank does not seek to compete broadly with regional or national retail banks.
GOVERNMENT REGULATION – TAX PREPARERS – Our tax preparation business is subject to various forms of government regulation, including the following:
U.S. Federal Tax Preparer Regulations. U.S. federal legislation requires income tax return preparers to, among other things, set forth their signatures and identification numbers, including their Preparer Tax Identification Number (PTIN), on all tax returns prepared by them and retain all tax returns prepared by them for three years. U.S. federal laws also subject income tax return preparers to accuracy-related penalties in connection with the preparation of income tax returns. Preparers may be prohibited from continuing to act as income tax return preparers if they continuously and repeatedly engage in specified misconduct.
The U.S. federal government regulates the electronic filing of income tax returns in part by requiring electronic filers to comply with all publications and notices of the IRS applicable to electronic filing. We are required to provide certain electronic filing information to taxpayers and comply with advertising standards for electronic filers. We are also subject to possible monitoring by the IRS, and if deemed appropriate, the IRS could impose various penalties, including penalties for improper disclosure or use of taxpayer information, other preparer penalties or suspension from the IRS electronic filing program.
Financial Privacy Regulations. The Gramm-Leach-Bliley Act and related Consumer Financial Protection Bureau (CFPB) and Federal Trade Commission (FTC) regulations require income tax preparers to (1) adopt and disclose consumer privacy notices, (2) provide consumers a reasonable opportunity to control (via "opt-out") whether their nonpublic personal information is disclosed to unaffiliated third-parties (subject to certain exceptions), and (3) implement reasonable safeguards to protect the security and confidentiality of nonpublic personal information. In addition, the IRS generally prohibits the use or disclosure of taxpayer information by tax return preparers for purposes other than tax return preparation without the prior written consent of the taxpayer.
State Regulations. Certain states have privacy laws and regulations similar to the U.S. federal regulations described above. Most states also have data security breach notice laws which may require notice to impacted individuals and others if there is unauthorized access to certain nonpublic personal information. Several states require income tax return preparers to, among other things, register as a return preparer and comply with certain registration requirements such as testing and continuing education requirements. State regulations also subject income tax return preparers to accuracy-related penalties in connection with the preparation of income tax returns, and may prohibit preparers from continuing to act as income tax return preparers if they continuously engage in specified misconduct. Certain states have regulations and requirements relating to offering income tax courses. These requirements may include licensing, bonding and certain restrictions on advertising.
Franchise Regulations. Many of the income tax return preparation offices operating in the U.S. under the name "H&R Block" are operated by franchisees. Our franchising activities are subject to the rules and regulations of the FTC, potential enforcement by the CFPB, and various state laws regulating the offer and sale of franchises. The FTC and various state laws require us to furnish to prospective franchisees a franchise disclosure document containing certain prescribed information. A number of states in which we are currently franchising regulate the sale of franchises and require registration of the franchise disclosure document with certain state authorities. We are currently operating under exemptions from registration in several of these states based on our net worth and experience. Substantive state laws regulating the franchisor/franchisee relationship presently exist in a large number of states, and bills have been introduced in Congress from time to time that would provide for federal regulation of the franchisor/franchisee relationship in certain respects. The state laws often limit, among other things, the duration and scope of non-competition provisions, the ability of a franchisor to terminate or refuse to renew a franchise and the ability of a franchisor to designate sources of supply. From time to time, we may make appropriate amendments to our franchise disclosure document to comply with our disclosure obligations under U.S. federal and state laws.
REGULATION AND SUPERVISION – BANK AND HOLDING COMPANIES – Our subsidiary, HRB Bank, is a federal savings bank chartered under the Home Owner's Loan Act, as amended (HOLA). Our Holding Companies are SLHCs because they control HRB Bank. The following is a general description of certain U.S. federal banking statutes and regulations that apply to HRB Bank and our Holding Companies.
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The Dodd-Frank Act. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) was signed into law on July 21, 2010. This federal statute made extensive changes to the laws regulating federal savings banks, their holding companies and other financial services companies. The Dodd-Frank Act requires various federal agencies to adopt many new rules and regulations. The federal agencies are given significant discretion in drafting the new rules and regulations; consequently, many of the details and much of the impact of the Dodd-Frank Act are still not clear.
The Dodd-Frank Act substantially restructured the regulation of federal savings associations and SLHCs. The Office of Thrift Supervision (OTS), which previously was the primary federal regulator for both HRB Bank and our Holding Companies, was eliminated. On July 21, 2011, the OTS transferred its regulatory authority to the Office of the Comptroller of the Currency (OCC) and the Federal Reserve. On that date, the OCC, the primary federal regulator for national banks, became the primary federal regulator for federal savings banks, including HRB Bank, and the Federal Reserve became the primary federal regulator for all SLHCs and their nonbank subsidiaries, including our Holding Companies and their nonbank subsidiaries.
The Dodd-Frank Act further limited the activities of SLHCs and their nonbank subsidiaries. The OTS had authorized SLHCs and their nonbank subsidiaries to engage in the broadest range of financial activities that could be engaged in by a bank holding company that has elected to be a financial holding company (FHC). Pursuant to the Dodd-Frank Act, the Federal Reserve has issued a regulation that SLHCs, and their nonbank subsidiaries, may only engage in such financial activities if the SLHCs qualify for and elect to become FHCs. Our Holding Companies have not elected to become FHCs and have no plans to do so.
The Dodd-Frank Act also weakened the federal preemption rules that have been applicable for national banks, federal savings banks and their subsidiaries, and gives state attorneys general the ability to enforce consumer protection laws. Prior to the enactment of the Dodd-Frank Act, OTS regulations provided that the HOLA, and the OTS regulations that interpret the HOLA, preempted the entire field of state regulation in the critical areas of lending and deposit-taking, resulting in federal preemption of most state consumer protection laws in those areas. The Dodd-Frank Act, effective July 21, 2011, changed the legal standard for federal savings association preemption of state laws to a "conflict" preemption standard that is the same as the standard for national bank preemption of state laws. The Dodd-Frank Act also eliminated, effective July 21, 2012, federal preemption for subsidiaries and affiliates of national banks and federal savings banks. As a result, state statutes and regulations that were previously not applicable to our nonbank subsidiaries are no longer preempted.
The Dodd-Frank Act also imposes consolidated capital requirements on SLHCs. These requirements may have a significant long term effect on our Holding Companies and, as a result, we are in the process of evaluating alternative means of ceasing to be an SLHC. See additional discussion in Item 1, under "Business," and in Item 8, note 2 to the consolidated financial statements. The Dodd-Frank Act required the Federal Reserve to promulgate minimum capital requirements for SLHCs, including leverage and risk-based capital requirements that are no less stringent than those applicable to banks at the time the Dodd-Frank Act was adopted.
Regulatory Supervision and Enforcement Authority. The OCC has extensive supervision and enforcement authority over all federal savings associations, including HRB Bank, and the Federal Reserve has extensive supervision and enforcement authority over all SLHCs, including our Holding Companies. Enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist and removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Public disclosure of final enforcement actions by the OCC or the Federal Reserve is generally required by law.
Federal Reserve Regulation of SLHCs. Each of our Holding Companies is a SLHC within the meaning of the HOLA. As such, they are registered as unitary SLHCs with the Federal Reserve and are subject to Federal Reserve regulations, examinations, supervision and reporting requirements. In addition, the Federal Reserve has supervisory and enforcement authority over our Holding Companies and their non-bank subsidiaries. Among other things, this authority permits the Federal Reserve to restrict or prohibit activities that are determined to be a serious risk to HRB Bank. Our Holding Companies are expected to be a source of strength to HRB Bank and able to commit capital and liquidity to the bank during times of economic stress.
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Bank Regulatory Capital Requirements. OCC regulations require HRB Bank to maintain specified minimum levels of regulatory capital. To be well capitalized, a federal savings association must have a leverage ratio of at least 5.0%, a Tier 1 risk-based capital ratio of at least 8.0% and a total risk-based capital ratio of at least 10.0%. To be adequately capitalized, a federal savings association must have a leverage ratio of at least 4.0%, a Tier 1 risk-based capital ratio of at least 6.0% and a total risk-based capital ratio of at least 8.0%. As of March 31, 2015, HRB Bank's most recent Call Report, HRB Bank was well-capitalized, with a leverage ratio of 34.7%, a Tier 1 risk-based capital ratio of 234.7%, and a total risk-based capital ratio of 236.0%. See Item 8, note 19 to the consolidated financial statements for discussion of dividends paid by HRB Bank.
In July 2013, the federal banking agencies issued final rules to implement changes that would increase the capital requirements for federal savings banks, including HRB Bank. The OCC has issued final capital regulations and the new capital regulations became effective for HRB Bank on January 1, 2015. See discussion under the heading "Regulatory Capital Requirements" below.
The OCC is authorized to take certain enforcement actions against federal savings banks that fail to meet the minimum ratios for an adequately capitalized institution and to impose other restrictions on federal savings banks that are less than adequately capitalized.
Regulatory Capital Requirements. In July 2013, the federal banking agencies issued final rules to implement changes required by the Dodd-Frank Act and to conform to the Basel III regulatory capital framework (the Basel III Capital Rules). The Basel III Capital Rules implement the Basel Committee's December 2010 framework known as "Basel III" for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The Basel III Capital Rules substantially revise the risk-based capital requirements applicable to depository institutions, compared to the current U.S. risk-based capital rules, and for the first time impose capital requirements on SLHCs. Our Holding Companies are SLHCs because they control HRB Bank. The Basel III Capital Rules became effective for our Holding Companies and HRB Bank on January 1, 2015, subject to phase-in periods as discussed below.
The Basel III Capital Rules, among other things, introduced a new capital measure called "Common Equity Tier 1," which will consist of common stock instruments and related surplus (net of treasury stock), retained earnings, and subject to certain adjustments, minority common equity interests in subsidiaries (CET1). When fully phased in on January 1, 2019, the Basel III Capital Rules will require SLHCs to maintain (1) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% "capital conservation buffer" (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7% upon full implementation), (2) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (3) a minimum ratio of total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation) and (4) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average total consolidated assets.
Under the Basel III Capital Rules, the initial minimum capital ratios that became effective on January 1, 2015 are as follows:
▪ | 4.5% CET1 to risk-weighted assets |
▪ | 6.0% Tier 1 capital to risk-weighted assets |
▪ | 8.0% Total capital to risk-weighted assets |
▪ | 4.0% leverage ratio |
The Basel III Capital Rules provide for a number of deductions from and adjustments to CET1. Deductions from CET1 include, among other items, goodwill and other intangibles and deferred tax assets, all net of associated deferred tax liabilities. Under current capital standards, the effects of accumulated other comprehensive income items included in capital are excluded for the purposes of determining regulatory capital ratios. Under the Basel III Capital Rules, the effects of certain accumulated other comprehensive income items would flow through to regulatory capital; however, certain banking organizations, including our Holding Companies and HRB Bank, may make a one-time permanent election to continue to exclude these items. Implementation of the deductions and other adjustments to CET1 began
H&R Block, Inc. | 2015 Form 10-K | 7 |
on January 1, 2015 and will be phased-in over a four-year period. The implementation of the capital conservation buffer will begin on January 1, 2016 and will be phased in over a four-year period.
The Basel III Capital Rules prescribe a standardized approach for risk weightings that expand the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset categories.
The prompt corrective action rules that apply to HRB Bank were amended effective January 1, 2015 to incorporate a CET1 capital requirement and to raise the capital requirements for certain capital categories. In order to be adequately capitalized for purposes of the prompt corrective action rules, a banking organization is required to have at least an 8.0% Total Risk-Based Capital Ratio, a 6.0% Tier 1 Risk-Based Capital Ratio, a 4.5% Common Equity Tier 1 Risk Based Capital Ratio and a 4.0% Tier 1 Leverage Ratio. To be well capitalized, a banking organization is required to have at least a 10.0% Total Risk-Based Capital Ratio, an 8.0% Tier 1 Risk-Based Capital Ratio, a 6.5% Common Equity Tier 1 Risk Based Capital Ratio and a 5.0% Tier 1 Leverage Ratio. Federal savings associations are required to calculate their prompt corrective action capital ratios in the same manner as national banks. Accordingly, tangible equity ratios are based on average total assets rather than period-end total assets.
As discussed in Item 1, under "Business," by consummating the Divestiture Transaction, our Holding Companies will cease to be SLHCs, in which case we would no longer be subject to regulation by the Federal Reserve as SLHCs.
Limitations on Dividends and Other Capital Distributions. OCC and Federal Reserve regulations impose various restrictions on federal savings banks with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases and other transactions charged to the capital account. Additionally, any distributions of capital or investments by our Holding Companies must be approved by the Federal Reserve.
Under OCC regulations, federal savings banks, such as HRB Bank, may generally make capital distributions during any calendar year equal to net income of the bank for the previous two calendar years, net of prior dividends paid by the bank, and current year-to-date net income. OCC regulations generally require that federal savings banks remain adequately capitalized before and after the proposed distribution. A federal savings bank proposing to make any capital distribution greater than these limits must obtain OCC approval prior to making such distributions. Because of the seasonal nature of our business and wide fluctuations in the level of HRB Bank's assets, our Holding Companies regularly make capital contributions to HRB Bank, and HRB Bank regularly seeks regulatory approval to repay such capital contributions as extraordinary dividends.
Consumer Protection Laws. In connection with its lending activities, HRB Bank is subject to federal laws designed to protect borrowers and promote lending, including the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and the Community Reinvestment Act (CR Act). In addition, federal banking regulations limit the ability of banks and other financial institutions to disclose nonpublic personal information to unaffiliated third parties. The CR Act requires the OCC to assess HRB Bank's record in meeting the credit needs of the communities served by HRB Bank, including low and moderate income neighborhoods. Under the CR Act, institutions are assigned a rating of outstanding, satisfactory, needs to improve, or substantial non-compliance. HRB Bank received a "satisfactory" rating in its most recent CR Act evaluation.
Bank Secrecy Act/Anti-Money Laundering Laws. HRB Bank is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA PATRIOT Act of 2001. These laws and regulations require HRB Bank to implement policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing, and to verify the identity of its customers. Violations of these requirements can result in substantial civil and criminal sanctions.
Qualified Thrift Lender Test. As a federal savings bank, HRB Bank is required to meet the Qualified Thrift Lender (QTL) test. This test requires HRB Bank to have at least 65% of its portfolio assets in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, HRB Bank may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under either test, HRB Bank is required to maintain a significant portion of its assets in residential housing related loans and investments. Any institution that fails to meet the QTL test is immediately subject to certain restrictions on its operations, unless it
8 | 2015 Form 10-K | H&R Block, Inc. |
requalifies as a QTL. These restrictions also include limitations on paying dividends. Failure to meet the QTL test is a statutory violation subject to enforcement action. As of April 30, 2015, 2014 and 2013, HRB Bank met the QTL test.
Insurance of Accounts. HRB Bank is subject to certain regulations issued by the Federal Deposit Insurance Corporation (FDIC), which insures the deposits of HRB Bank to the maximum extent permitted by law. This regulation of HRB Bank is intended for the protection of its depositors.
The FDIC insures HRB Bank's deposit accounts. The FDIC assesses deposit insurance premiums on each FDIC-insured institution based on its capital, supervisory ratings, and other factors.
Transactions with Affiliates. Transactions between HRB Bank and its affiliates are required to be on terms at least as favorable to HRB Bank as transactions with non-affiliates, and certain covered transactions are restricted to a percentage of HRB Bank's capital.
Federal Home Loan Bank System. HRB Bank is a member of the Federal Home Loan Bank of Des Moines (FHLB), which serves as a reserve or central bank for its members and makes loans or advances to its members. As of April 30, 2015 and 2014, HRB Bank had no outstanding advances from the FHLB.
Consumer Financial Protection Bureau. The Dodd-Frank Act created the CFPB to administer and, in some cases, enforce U.S. federal consumer protection laws and expanded the role of state regulators with respect to consumer protection laws. The CFPB may issue regulations that apply to HRB Bank, and to our non-bank subsidiaries that provide consumer financial services and products. The CFPB may examine, and take enforcement actions against, our non-bank subsidiaries. See Item 1A for further information on the CFPB.
See Item 7, under "Regulatory Environment," and Item 8, note 19 to the consolidated financial statements for additional discussion of regulatory requirements.
FOREIGN REGULATIONS – We are also subject to a variety of other regulations in various foreign markets, including anti-corruption laws and regulations concerning privacy, data protection and data retention. Foreign regulations and laws potentially affecting our business are evolving rapidly. We rely on external counsel in the countries in which we do business to advise us regarding compliance with applicable laws and regulations. As our international operations grow, we continue to develop and enhance our internal legal and operational compliance programs that guide our businesses in complying with laws and regulations applicable in the countries in which we do business.
SERVICE MARKS, TRADEMARKS AND PATENTS
We have made a practice of offering our services and products under service marks and trademarks and of securing registration for many of these marks in the U.S. and other countries where our services and products are marketed. We consider these service marks and trademarks, in the aggregate, to be of material importance to our business, particularly our businesses providing services and products under the "H&R Block" brand. The initial duration of U.S. federal trademark registrations is 10 years. Most U.S. federal registrations can be renewed perpetually at 10-year intervals and remain enforceable so long as the marks continue to be used.
We hold a small but growing patent portfolio that we believe is important to our overall competitive position, although we are not materially dependent on any one patent or particular group of patents in our portfolio at this time.
Our patents have remaining terms generally ranging from one to 20 years.
EMPLOYEES AND EXECUTIVE OFFICERS
We had approximately 2,200 regular full-time employees as of April 30, 2015. Our business is dependent on the availability of a seasonal workforce, including tax professionals, and our ability to hire, train, and supervise these employees. The highest number of persons we employed during the fiscal year ended April 30, 2015, including these seasonal employees, was approximately 98,600.
H&R Block, Inc. | 2015 Form 10-K | 9 |
Information about our executive officers is as follows:
Name, age | Current position | Business experience since May 1, 2010 | ||
William C. Cobb, age 58 | President and Chief Executive Officer | President and Chief Executive Officer since May 2011; retired from eBay, Inc. in 2008, having worked there from November 2000 to March 2008, where he most recently served as President of eBay Marketplaces North America for four years; before that, he held several senior management positions, including Senior Vice President and General Manager of eBay International and Senior Vice President of Global Marketing. | ||
Gregory J. Macfarlane, age 45 | Chief Financial Officer | Chief Financial Officer since June 2012; Executive Vice President and Chief Financial Officer of Ceridian Corporation from March 2007 until August 2011. | ||
Jeffrey T. Brown, age 56 | Chief Accounting and Risk Officer | Chief Accounting and Risk Officer since June 2012; Senior Vice President and Chief Financial Officer from September 2010 until June 2012; Interim Chief Financial Officer from May 2010 to September 2010; Vice President and Corporate Controller from March 2008 until September 2010. | ||
Thomas A. Gerke, age 59 | Chief Legal Officer | Chief Legal Officer (formerly titled Senior Vice President and General Counsel) since January 2012; Executive Vice President, General Counsel and Secretary of YRC Worldwide from January 2011 until April 2011; Executive Vice Chairman, Century Link, Inc. from July 2009 until December 2010. | ||
Delos L. ("Kip") Knight, III, age 58 | President, U.S. Retail Operations | President, U.S. Retail Operations since October 2013; President, International and U.S. Franchise Operations from April 2012 until October 2013; President of KnightVision Marketing from August 2008 until April 2012. Prior to 2008, Mr. Knight held various positions at eBay, Yum! Restaurants International, PepsiCo and Procter & Gamble. | ||
Jason L. Houseworth, age 40 | President, U.S. Tax Product Strategy and Development | President, U.S. Tax Product Strategy and Development since April 2015; President, Global Digital and Product Management from May 2013 until April 2015; President, U.S. Tax Services from May 2012 until May 2013; Senior Vice President, Digital Tax Solutions from February 2011 until May 2012; Vice President, Technology from July 2008 until February 2011. | ||
AVAILABILITY OF REPORTS AND OTHER INFORMATION
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed with or furnished to the SEC are available, free of charge, through our website at www.hrblock.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. The public may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website at www.sec.gov containing reports, proxy and information statements and other information regarding issuers who file electronically with the SEC.
The following corporate governance documents are posted on our website at www.hrblock.com:
▪ | The Amended and Restated Articles of Incorporation of H&R Block, Inc.; |
▪ | The Amended and Restated Bylaws of H&R Block, Inc.; |
▪ | The H&R Block, Inc. Corporate Governance Guidelines; |
▪ | The H&R Block, Inc. Code of Business Ethics and Conduct; |
▪ | The H&R Block, Inc. Board of Directors Independence Standards; |
▪ | The H&R Block, Inc. Audit Committee Charter; |
▪ | The H&R Block, Inc. Compensation Committee Charter; |
▪ | The H&R Block, Inc. Finance Committee Charter; and |
▪ | The H&R Block, Inc. Governance and Nominating Committee Charter. |
If you would like a printed copy of any of these corporate governance documents, please send your request to H&R Block, Inc., One H&R Block Way, Kansas City, Missouri 64105, Attention: Corporate Secretary.
Information contained on our website does not constitute any part of this report.
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ITEM 1A. RISK FACTORS
Our business activities expose us to a variety of risks. Identification, monitoring and management of these risks are essential to the success of our operations and the financial soundness of H&R Block. Senior management and the Board of Directors, acting as a whole and through its committees, take an active role in our risk management process and have delegated certain activities related to the oversight of risk management to the Company's Risk Committee, which is comprised of senior managers of major businesses and control functions. The Risk Committee is responsible for identifying and monitoring risk exposures and leading the continued development of our risk management policies and practices.
An investment in our securities involves risk, including the risk that the value of an investment may decline or that returns on that investment may fall below expectations. There are a number of significant factors that could cause actual conditions, events or results to differ materially from those described in forward-looking statements, many of which are beyond management's control or its ability to accurately estimate or predict, or that could adversely affect our financial position, results of operations, cash flows and the value of an investment in our securities.
RISKS RELATING TO CONTINUING OPERATIONS
Increased competition for tax preparation clients could adversely affect our current market share and profitability. Offers of free tax preparation services could adversely affect our revenues and profitability.
We provide both assisted and DIY tax preparation services and products and face substantial competition throughout our businesses. All categories in the tax preparation industry are highly competitive. In the assisted tax services category, there are a substantial number of tax return preparation firms and accounting firms offering tax return preparation services. Commercial tax return preparers are highly competitive with regard to price and service. In the DIY category, options include the use of traditional paper forms and various forms of digital electronic assistance, including online, mobile, and desktop software, all of which we offer. Our DIY services and products compete with a number of online and software companies, primarily on the basis of price and functionality. Individual tax filers may elect to change their tax preparation method, choosing from among various assisted and DIY offerings. Additionally, many tax return preparation firms are involved in providing RTs and other tax-related services and products. Intense price competition could result in a reduction of our market share, lower revenues, lower margins and lower profitability.
U.S. federal and certain state taxing authorities, as well as taxing authorities in certain foreign jurisdictions in which we operate, currently offer, or facilitate the offering of, tax return preparation and electronic filing options to taxpayers at no charge, and volunteer organizations prepare tax returns at no charge for low-income taxpayers. In addition, many of our competitors offer certain tax preparation services and products and electronic filing options at no charge. In order to compete, we offer certain free tax preparation services and products at no charge. We enabled the preparation of 676 thousand, 767 thousand and 663 thousand U.S. federal income tax returns in fiscal years 2015, 2014 and 2013, respectively, at no charge through the FFA. We also provided free Federal 1040EZ filings online and in retail offices in fiscal year 2013. There can be no assurance that we will be able to attract clients or effectively ensure the migration of clients from our free tax service offerings to those for which we receive fees, and clients who have formerly paid for our tax service offerings may elect to use free offerings instead. These competitive factors may diminish our revenue and profitability, or harm our ability to acquire and retain clients.
Government tax authorities, volunteer organizations, and our direct competitors may also elect to expand free offerings in the future. From time to time U.S. federal and state governments have considered various proposals (often referred to as "Return-Free Filing" or "Pre-Populated Returns") through which the respective governmental taxing authorities would use taxpayer information provided by employers, financial institutions, and other payers to "pre-populate," prepare and calculate tax returns and distribute them to taxpayers. Under this approach, the taxpayer could then review and contest the return or sign and return it. Although the FFA has kept the federal government from becoming a direct competitor to our tax service offerings in the U.S., it fosters additional online competition and may cause us to lose significant revenue opportunities. We believe that governmental encroachment at both the U.S. federal and state levels, as well as comparable government levels in foreign jurisdictions in which we operate, could present a continued competitive threat to our business for the foreseeable future.
See tax returns prepared statistics included in Item 7, under "Tax Services – Operating Statistics."
H&R Block, Inc. | 2015 Form 10-K | 11 |
Failure to comply with laws and regulations that protect our clients' and employees' personal information could harm our brand and reputation and could result in significant fines, penalties, and damages.
In the course of our business, we collect, use, and retain large amounts of personal client information and data, including tax return information, bank account numbers, and social security numbers. In addition, we collect and maintain personal information of our employees in the ordinary course of our business. The Company holds some of this personal information and third parties execute some transactions utilizing this information. We use security and business controls to limit access to and use of personal information, but unauthorized individuals or third parties may be able to circumvent these security and business measures, which could require us to notify affected clients or employees under applicable privacy laws and regulations. We employ contractors and temporary employees who may have access to the personal information of clients and employees or who may execute transactions in the normal course of their duties. While we conduct employee background checks, as allowed by law, and limit access to systems and data, it is possible that one or more of these controls could be circumvented. Improper disclosure or use of our clients' or employees' personal information could result in damage to our brand and reputation, and actions required to remediate improper disclosures could be costly.
We are subject to laws, rules, and regulations relating to the collection, use, disclosure, and security of consumer and employee personal information, which have drawn increased attention from U.S. federal and state governments, as well as governmental authorities in foreign jurisdictions in which we operate. In the U.S., the IRS generally requires a tax return preparer to obtain the prior written consent of the taxpayer to use or disclose the taxpayer's information for certain purposes other than tax return preparation. In addition, other regulations require financial service providers to adopt and disclose consumer privacy notices and provide consumers with a reasonable opportunity to "opt-out" of having nonpublic personal information disclosed to unaffiliated third parties. Several jurisdictions have passed new laws in this area and it continues to be an area of interest across multiple jurisdictions. These laws may be interpreted and applied inconsistently from jurisdiction to jurisdiction, and our current data protection policies and practices may not be consistent with all of those interpretations and applications. In addition, changes in the U.S. federal and state regulatory requirements, as well as requirements imposed by governmental authorities in foreign jurisdictions in which we operate, could result in more stringent requirements and in a need to change business practices, including the types of information we can use and the manner in which we can use such information. Establishing systems and processes to achieve compliance with these new requirements may increase costs or limit our ability to pursue certain business opportunities.
A security breach of our systems, or third party systems on which we rely, resulting in access to personal client information may adversely affect the demand for our services and products, our reputation, and financial performance.
We offer a range of services and products to our clients, including assisted and DIY tax services and banking services provided by HRB Bank. Due to the nature of these services and products, we use multiple digital technologies to collect, transmit, and store high volumes of personal client information. Information security risks to companies that use digital technologies continue to increase due in part to the increased adoption of and reliance upon these technologies by companies and consumers. Our risk and exposure to these matters remain heightened due to a variety of factors including, among other things, the evolving nature of these threats and related regulation, the increased sophistication of organized crime, cyber criminals and hackers, the prominence of our brand, our and our franchisees' extensive office footprint, our plans to continue to implement our DIY and mobile channel strategies, and our use of third party vendors.
Cybersecurity risks may result from fraud or malice (a cyber attack), human error, or accidental technological failure. Cyber attacks are designed to electronically circumvent network security for malicious purposes including unlawfully obtaining personal client information, disrupting our ability to offer services, damaging our brand and reputation, stealing our intellectual property, and advancing social or political agendas. We face a variety of cyber attack threats including computer viruses, malicious codes, worms, phishing attacks, social engineering, denial of service attacks, and other sophisticated attacks.
We maintain multiple levels of protection in order to address or otherwise mitigate the risk of a security breach. We regularly test our systems to discover and address potential vulnerabilities. Cybersecurity and the continued development and enhancement of our controls, processes, and practices designed to protect our systems, computers, software, data, and networks from attack, damage, or unauthorized access remain a high priority for us. As risks and
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regulations continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Due to the structure of our business model, we also rely on our franchisees and other private and governmental third parties to maintain secure systems and respond to cybersecurity risks. Notwithstanding these efforts, there can be no assurance that a security breach, intrusion, or loss or theft of personal client information will not occur.
A breach of our security measures or those of our franchisees or third parties on whom we rely, or other fraudulent activity, could result in unauthorized access to personal client information. If such an event were to occur, it could have serious short and long term negative consequences. Security breach remediation could require us to expend significant resources to notify or assist impacted clients, repair damaged systems, implement improved information security measures, and maintain client and business relationships. Other consequences could include reduced client demand for our services and products, reduced growth and profitability and negative impacts to future financial results, loss of our ability to deliver one or more services or products (e.g., inability to provide financial transaction services or to accept and process client credit card orders or tax returns), litigation, harm to our reputation and brands, fines, penalties, and other damages, and further regulation and oversight by U.S. federal, state, or foreign governmental agencies.
A security breach or other unauthorized access to our systems could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
Stolen identity refund fraud could impede our clients' ability to timely and successfully file their tax returns and receive their tax refunds, and could diminish consumers' perceptions of the security and reliability of our products and services, resulting in negative publicity.
Companies offering DIY tax preparation services have seen a rise in instances of criminals utilizing stolen information obtained through hacking, phishing, and other means of identity theft in order to electronically file fraudulent federal and state tax returns. As a result, an increasing number of taxpayers must complete additional forms and go through additional steps in order to report to appropriate authorities that their identities have been stolen and their tax returns were filed fraudulently. While we offer assistance in the refund recovery process and have introduced Tax Identity Shield℠ to help protect clients, stolen identity refund fraud could impede our clients' ability to timely and successfully file their returns and receive their tax refunds, and could diminish consumers' perceptions of the security and reliability of our products and services, resulting in negative publicity, despite there having been no breach in the security of our systems. In addition, if stolen identity refund fraud is perpetrated through our products or services, state or federal tax authorities may refuse to allow us to continue to process our clients' tax returns electronically. As a result, stolen identity refund fraud could harm our revenue, results of operations and reputation.
In addition, our clients may access our services and products from personal or public computers and mobile devices and may install and use our H&R Block DIY desktop tax preparation software on their computers. As a result, a person with malicious intent could obtain user account and password information through hacking, phishing, or other means of cyber attack, in order to perpetrate stolen identity refund fraud and otherwise cause losses for our clients. It has been reported that a number of companies, including some in the tax return preparation industry, have recently experienced instances where criminals gained unauthorized and illegal access to their systems by using stolen identity information obtained from sources other than those companies. The unauthorized and illegal access to those systems was used by criminals to perpetrate a variety of crimes, including stolen identity refund fraud. We could experience this form of unauthorized and illegal access to our systems, despite there having been no breach in the security of our systems, which could negatively impact our clients and harm our revenue, results of operations and reputation. Additionally, if such unauthorized or illegal access occurs, we may be subject to claims and litigation by clients, non-clients, or governmental agencies.
An interruption in our information systems, or those of our franchisees or a third party on which we rely, or an interruption in the internet, could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
We and our franchisees rely heavily upon communications and information systems and the internet to conduct our business. Our, and our franchisees', systems and operations are potentially vulnerable to damage or interruption from upgrades and maintenance, network failure, hardware failure, software failure, power or telecommunications failures, cyber attacks involving the penetration of our network by hackers or other unauthorized users through computer
H&R Block, Inc. | 2015 Form 10-K | 13 |
viruses and worms, malicious code, phishing attacks, denial of service attacks, or information security breaches, other negative disruptions to the operation of the internet, and natural disasters. Any failure or interruption in our information systems, or information systems of our franchisees or a private or government third party on which we rely, or an interruption in the internet or other critical business capability, could negatively impact our business operations and increase our risk of loss. As our businesses are seasonal, our systems must be capable of processing high volumes during our peak periods. Therefore, service interruptions resulting from system or internet failures could negatively impact our ability to serve our clients, which in turn could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
There can be no assurance that system or internet failures, or interruptions in critical business capabilities will not occur, or if they do occur that we, our franchisees or the private or governmental third parties on whom we rely, will adequately address them. The precautionary measures that we have implemented to avoid systems outages and to minimize the effects of any data or communication systems interruptions or failures may not be adequate, and we may not have anticipated or addressed all of the potential events that could threaten or undermine our information systems or other critical business capabilities. The occurrence of any systems or internet failure, or business interruption, could negatively impact our ability to serve our clients, which in turn could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
Government initiatives that simplify tax return preparation or expedite refunds could reduce the need for our services as a third-party tax return preparer, and cause our revenues or results of operations to decline.
Many taxpayers seek assistance from paid tax return preparers such as us not only because of the level of complexity involved in the tax return preparation and filing process, but also because of paid tax return preparers' ability to expedite refund proceeds under certain circumstances. From time to time, the IRS or members of Congress propose measures seeking to simplify the preparation and filing of federal tax returns, including preparation of tax returns directly by the IRS, and to provide additional assistance with respect to preparing and filing such tax returns or expediting refunds. H&R Block is a member of the FFA, which provides the ability for low-income taxpayers to prepare and file their own federal tax return online for free. The IRS has been exploring the Real Time Tax System concept, which would require that documents (such as W-2s and 1099s) must be on file with the IRS prior to the taxpayer submitting their tax return. The objective of this concept would be to facilitate document matching such that it would reduce fraud and after-the-fact audits. The implementation of the Real Time Tax System would provide a foundation for the IRS preparation of tax returns and make the pre-populated return a more tangible possibility.
In 2011, the U.S. Department of the Treasury completed a prepaid debit card pilot program designed to facilitate the refund process. HRB Bank also provides this type of service through its H&R Block Emerald Prepaid MasterCard®. Additionally, the IRS has in the past explored the possibility of allowing taxpayers to allocate a portion of their tax refund to pay tax preparation fees, which could reduce the demand for RTs, but the IRS has not advanced this initiative. Taxing authorities in various state, local, and foreign jurisdictions in which we operate have also introduced measures seeking to simplify the preparation and filing of tax returns in their respective jurisdictions. The adoption or expansion of any measures that significantly simplify tax return preparation, expedite refunds, or otherwise reduce the need for a third-party tax return preparer could reduce demand for our services and products and could have a material adverse effect on our business and our consolidated financial position, results of operations and cash flows.
Federal Reserve capital regulations impose various requirements and restrict our capital allocation strategies and we are therefore pursuing a strategy which would cause our Holding Companies to cease being SLHCs. If our Holding Companies were to cease being SLHCs, the means we use to deliver financial services and products to our customers and the revenues and profitability of those offerings could be adversely impacted.
Our subsidiary, HRB Bank, is a federal savings bank. Our Holding Companies are SLHCs because they control HRB Bank.
The Dodd-Frank Act requires the Federal Reserve to promulgate minimum capital requirements for SLHCs, including leverage and risk-based capital requirements that are no less stringent than those applicable to insured depository institutions at the time the Dodd-Frank Act was enacted. On July 2, 2013, the Federal Reserve approved the Basel III Capital Rules, which implement a revised definition of regulatory capital, a new common equity tier 1 minimum capital requirement, and a higher minimum tier 1 capital requirement (Revised Capital Rules). The rule also requires certain levels of equity for the payment of dividends and bonuses, and amends the methodologies for risk-weighting assets.
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The Revised Capital Rules became effective for us on January 1, 2015. See Item 1, "Regulation and Supervision - Bank and Holding Companies," for details of the new requirements.
The Federal Reserve, the Holding Companies' primary banking regulator, has issued guidance set forth in Supervisory Letter SR 09-4 (March 27, 2009) regarding the payment of dividends, stock redemptions and stock repurchases by bank holding companies. Pursuant to Supervisory Letter SR 11-11 (July 21, 2011), the Federal Reserve has directed examiners to apply the principles of SR 09-4 to SLHCs. Pursuant to SR 09-4, we have committed to provide notice to the Federal Reserve prior to paying dividends or repurchasing shares.
The Revised Capital Rules will require our Holding Companies to retain significant additional capital, even though HRB Bank has regulatory capital substantially above the "well capitalized" level. We do not foresee any regulatory flexibility in this regard in light of the Federal Reserve's views of the statutory requirements imposed under the Dodd-Frank Act. Accordingly, while our current belief is that the Federal Reserve would permit dividends to continue at current levels as long as H&R Block, Inc. remains adequately capitalized (with a sufficient capital buffer) and HRB Bank remains well capitalized, the Federal Reserve will closely supervise and likely restrict our other capital allocation decisions, including stock repurchases, acquisitions, and other forms of strategic investment.
On April 10, 2014, we entered into the P&A Agreement with BofI. In connection with the closing of the P&A Transaction, HRB Bank will convert into a national banking association, merge with and into Block Financial, surrender its bank charter, and cease to operate as a separate legal entity. At that time, our Holding Companies would no longer be SLHCs subject to regulatory oversight of the Federal Reserve or related regulatory capital requirements. See additional discussion in Item 1, under "Business," and Item 8, note 2 to the consolidated financial statements.
Although we are selling certain assets and liabilities and surrendering the charter of HRB Bank, we plan to continue to enhance our business by delivering financial services and products to our clients. In connection with the execution of the P&A Agreement, we plan to enter into certain other agreements with BofI concurrent with the closing of the Divestiture Transaction, including, without limitation a Program Management Agreement, including related product schedules (PMA), and a related Emerald Advance Receivables Participation Agreement (RPA). An operating subsidiary of the Company will provide certain marketing, servicing, and operational support to BofI with respect to such financial services and products.
The obligations of the parties to complete the P&A Transaction and the other transactions discussed herein are subject to the fulfillment of numerous conditions, including, but not limited to: (1) receipt of all regulatory approvals necessary to consummate the entire Divestiture Transaction; (2) receipt of a required third party consent; and (3) the execution and delivery of the PMA and the RPA. We cannot be certain when or if the conditions to and other components of the P&A Transaction will be satisfied, or whether the P&A Transaction will be completed. In addition, there may be changes to the terms and conditions of the P&A Agreement, PMA, RPA, and other contemplated agreements as part of the regulatory approval process.
HRB Bank is subject to extensive U.S. federal banking laws and regulations. If we fail to comply with applicable banking laws and regulations, we could be subject to enforcement actions, damages, penalties, or restrictions that could significantly harm our business.
As previously announced, we are pursuing the Divestiture Transaction, pursuant to which we will no longer be subject to regulation as an SLHC and HRB Bank would surrender its bank charter and cease to exist as a separate legal entity. However, there can be no assurance regarding the timing of consummation of the Divestiture Transaction, or whether the Divestiture Transaction will be consummated at all. Until such time as the Divestiture Transaction is consummated, HRB Bank remains subject to regulation, examination, supervision, reporting requirements, and enforcement by the OCC. The OCC can, among other things, issue cease-and-desist orders, assess civil money penalties, and remove bank directors, officers or employees, for violations of banking laws and regulations or engaging in activities it determines to be unsafe and unsound banking practices.
HRB Bank is subject to OCC regulatory capital requirements. Failure to meet minimum capital requirements may trigger actions by regulators that could have a direct, material effect on HRB Bank. HRB Bank must meet specific capital requirements involving quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. OCC regulations currently require HRB Bank to maintain minimum amounts and ratios of tangible equity, total risk-based capital and Tier 1 capital.
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The laws and regulations imposed by U.S. federal banking regulators generally involve restrictions and requirements in connection with a variety of technical, specialized, and expanding matters and concerns. For example, compliance with anti-money laundering, know-your-customer requirements, and the Bank Secrecy Act, has taken on heightened importance with regulators as a result of efforts to limit terrorism. There has been increased regulation with respect to the protection of customer privacy and the need to secure sensitive customer information. Being subject to banking regulation may put us at a disadvantage compared to our competitors which may not be subject to such requirements.
The OCC could deem certain products offered by HRB Bank to be "unsafe and unsound" and require HRB Bank, or a third party on which we rely, to discontinue offering such products. The discontinuance of offering such products would result in a loss of revenues derived from such products and to the extent such products are instrumental in attracting clients to our offices for tax preparation services, we could experience a significant loss of clients should such products be discontinued. This could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
The Dodd-Frank Act created the CFPB to administer and, in some cases, enforce U.S. federal consumer protection laws and expanded the role of state regulators with respect to consumer protection laws. Regulations promulgated by the CFPB or state regulators may affect our bank and financial services businesses in ways we cannot predict, which may require changes to our financial products, services, and contracts.
The Dodd-Frank Act created the CFPB and gave it broad powers to administer, investigate compliance with, and, in some cases, enforce U.S. federal consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks, federal savings banks, and other financial services companies, including the authority to prohibit "unfair, deceptive, or abusive" acts and practices. The CFPB has examination and enforcement authority over all banks with more than $10 billion in assets and certain other companies not regulated by the federal bank regulators. Banks with $10 billion or less in assets will continue to be examined for compliance with the consumer laws by their primary federal bank regulators. HRB Bank does not currently have assets in excess of $10 billion.
Although the CFPB has extensive rulemaking, investigative, and enforcement powers that could impact our business operations, the potential reach of the CFPB's authority on the operations of banks and financial services companies offering consumer financial services or products, including our bank and financial services subsidiaries, is still developing. The CFPB may examine, investigate, and take enforcement actions against our non-bank subsidiaries that provide consumer financial services and products. The Dodd-Frank Act also expanded the role of state regulators in enforcing and promulgating consumer protection laws, the results of which could be states issuing new and broader consumer protection laws, some of which could be more comprehensive than U.S. federal regulations. New CFPB and state regulations may require changes to our financial products, services and contracts, and this could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
The nature of our tax service and product offerings requires timely product launches. Any significant delays in launching our tax service and product offerings, changes in government regulations or processes that affect how we provide such offerings to our clients, or significant problems with such offerings or the manner in which we provide them to our clients may harm our revenue, results of operations, and reputation.
Tax laws and tax forms are subject to change each year, and the nature and timing of such changes are unpredictable. As a part of our business, we must incorporate any changes to tax laws and tax forms into our tax service and product offerings, including our online tax services and desktop tax preparation software. The unpredictable nature and timing of changes to tax laws and tax forms can result in condensed development cycles for our tax service and product offerings because our clients expect high levels of accuracy and a timely launch of such offerings to prepare and file their taxes by the tax filing deadline and, in turn, receive any tax refund amounts on a timely basis. In addition, governmental authorities regularly change their processes for accepting tax filings and related tax forms. Changes in governmental regulations and processes that affect how we provide services and products to our clients may require us to make corresponding changes to our client service systems and procedures. Furthermore, unanticipated changes in governmental processes for accepting tax filings and related forms, or the ability of taxing authorities to accept electronic tax return filings, may result in delays in processing our clients' tax filings, or delays in tax authorities accepting electronic tax return filings, and, in turn, delay any tax refund amounts to which such clients may be entitled. From time to time, we review and enhance our quality controls for preparing accurate tax returns, but there can be no assurance that we will be able to prevent all inaccuracies. Any significant delays in launching our tax service and
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product offerings, changes in government regulations or processes that affect how we provide such offerings to our clients, or significant problems with such offerings or the manner in which we provide them to our clients may harm our revenue, results of operations, and reputation.
If we encounter development challenges or discover errors in our systems, services or products, we may elect to delay or suspend our offerings. Any major defects or launch delays, or failure to anticipate changes in governmental processes for accepting tax filings and related forms, may lead to loss of clients and revenue, negative publicity, client and employee dissatisfaction, a deterioration in our business relationships with our franchisees, reduced retailer shelf space and promotions, exposure to litigation, and increased operating expenses. Any of the risks described above could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
We rely on a single vendor or a limited number of vendors to provide certain key services or products, and the inability of these key vendors to meet our needs could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
Historically, we have contracted, and in the future we will likely continue to contract, with a single vendor or a limited number of vendors to provide certain key services or products for our tax, financial, and other services and products. One example of this type of reliance is our relationship with FIS and another is our expected relationship with BofI. In certain instances, we are vulnerable to vendor error, service inefficiencies, service interruptions, or service delays. Our sensitivity to any of these issues may be heightened (1) due to the seasonality of our business, (2) with respect to any vendor that we utilize for the provision of any product or service that has specialized expertise, (3) with respect to any vendor that is a sole provider, or (4) with respect to any vendor whose indemnification obligations are limited or that does not have the financial capacity to satisfy its indemnification obligations. Some of our vendors are subject to the oversight of regulatory bodies and, as a result, our product or service offerings may be affected by the actions or decisions of such regulatory bodies. Vendor failures could occur in various ways including (1) vendor error, (2) inability to meet our needs in a timely manner, or (3) termination or delay in the services or products provided by a vendor because the vendor failed to perform adequately, is no longer in business, experiences shortages, or discontinues a certain product or service that we utilize. If our vendors are unable to meet our needs and we are not able to develop alternative sources for these services and products quickly and cost-effectively, it could result in a material and adverse impact on our business and our consolidated financial position, results of operations, and cash flows.
The highly seasonal nature of our business presents financial risks and operational challenges, which, if not satisfactorily addressed, could materially affect our business and our consolidated financial position, results of operations, and cash flows.
Our business is highly seasonal, with the substantial portion of our revenue earned in the fourth quarter of our fiscal year. The concentration of our revenue-generating activity during this relatively short period presents a number of challenges for us, including (1) cash and resource management during the first nine months of our fiscal year, when we generally operate at a loss and incur fixed costs and costs of preparing for the upcoming tax season, (2) ensuring compliance with financial covenants under our debt agreements, particularly if the timing of our revenue generation deviates from this seasonal period, (3) the availability of a seasonal workforce, including tax professionals, and our ability to hire, train, and supervise these employees, (4) responding to changes in competitive conditions, including marketing, pricing, and new product offerings, which could affect our position during the tax season, (5) disruptions in a tax season, including any customer dissatisfaction issues, which may not be timely discovered, and (6) ensuring optimal uninterrupted operations and service delivery during peak season. If we experience significant business disruptions during the tax season or if we are unable to satisfactorily address the challenges described above and related challenges associated with a seasonal business, we could experience a loss of business, which could have a material adverse effect on our business and our consolidated financial position, results of operations and cash flows.
We face substantial litigation in connection with our various business activities, and such litigation may damage our reputation, impair our product offerings, or result in material liabilities and losses.
We have been named, and from time to time will likely continue to be named, as a defendant in various legal actions, including arbitrations, class actions, actions or inquiries by state attorneys general, and other litigation arising in connection with our various business activities, including relating to our various service and product offerings. We
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also grant our franchisees a limited license to use our registered trademarks and, accordingly, there is risk that one or more of the franchisees may be identified as being controlled by us. Third parties, regulators or courts may seek to hold us responsible for the actions or failures to act by our franchisees. Adverse outcomes related to litigation could result in substantial damages and could cause our earnings to decline. Negative public opinion could also result from our subsidiaries' or franchisees' actual or alleged conduct in such claims, possibly damaging our reputation, which, in turn, could adversely affect our business prospects and cause the market price of our securities to decline.
In addition, we have been sued, and certain of our competitors have been sued, in connection with the offering of different types of RT products. Further, we have received an inquiry from the California Attorney General requesting information regarding our RT product. In a case involving one of our competitors, a California appellate court affirmed a trial court's ruling that the competitor's specific version of a RT product was subject to truth-in-lending and other related laws. Following the appellate court's ruling, the case was denied further appellate review. We believe there are differences that distinguish our RT product from the product that was the subject of the competitor's case described above. Revenues from our RT product totaled $171 million in fiscal year 2015; any requirement that materially alters our offering of RTs, including limitations on the fees we charge or disclosure requirements that could reduce the demand for these products, could have a material adverse impact on our business and our consolidated financial position, results of operations, and cash flows.
Our access to liquidity may be negatively impacted as disruptions in credit markets occur, if credit rating downgrades occur, or if we fail to meet certain covenants. Funding costs may increase, leading to reduced earnings.
We need liquidity to meet our off-season working capital requirements, to service debt obligations including refinancing of maturing obligations, and for general corporate purposes. Our access to and the cost of liquidity could be negatively impacted in the event of credit rating downgrades or if we fail to meet existing debt covenants. In addition, events could occur which could increase our need for liquidity above current levels.
If rating agencies downgrade our credit rating, the cost of debt under our existing financing arrangements, as well as future financing arrangements and borrowings under our commercial paper program, could increase and capital market access could decrease or become unavailable. Our unsecured committed line of credit (2012 CLOC) is subject to various covenants, and a violation of a covenant could impair our access to liquidity currently available through the 2012 CLOC. The 2012 CLOC includes provisions that allow for the issuance of equity to comply with the financial covenant calculations as a means to avoid a shortfall. If current sources of liquidity were to become unavailable, we would need to obtain additional sources of funding, which may not be available or may only be available under less favorable terms. This could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
The continued payment of dividends on our common stock and repurchases of our common stock are dependent on a number of factors, and future payments and repurchases cannot be assured.
We need liquidity sufficient to fund payments of dividends on our common stock and repurchases of our common stock. In addition, holders of our common stock are only entitled to receive such dividends as our Board of Directors may declare out of funds legally available for such payments, and our Board of Directors may only authorize the Company to repurchase shares of our common stock with funds legally available for such repurchases. The payment of future dividends and future repurchases will depend upon our earnings, economic conditions, liquidity and capital requirements, and other factors, including our debt leverage. Accordingly, we cannot make any assurance that future dividends will be paid, or future repurchases will be made, at levels comparable to our historical practices, if at all. Due to the seasonal nature of our business and the fact that our business is not asset-intensive, there may be periods of time during our fiscal year in which the payment of dividends or stock repurchases may cause us to have a negative net worth under accounting principles generally accepted in the U.S. (GAAP). See additional discussion regarding our provision of notice to the Federal Reserve prior to paying dividends or repurchasing shares in the risk factor related to the Federal Reserve capital requirements.
Our businesses may be adversely affected by difficult economic conditions, in particular, high unemployment levels.
Difficult economic conditions are frequently characterized by high unemployment levels and declining consumer and business spending. These poor economic conditions may negatively affect demand and pricing for our services and products. Higher unemployment levels, especially within client segments we serve, may result in clients electing not
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to file tax returns or clients seeking lower cost preparation and filing alternatives. Sustained levels of high unemployment may negatively impact our ability to increase or retain tax preparation clients.
Economic conditions that negatively affect housing prices and the job market may result in deterioration in credit quality of mortgage loans held for investment and other loans, and such deterioration could have a negative impact on our business and profitability. The fair value of these mortgage loans is less than their carrying value and a decision by us to no longer hold these loans for investment would result in a significant impairment.
The overall credit quality of mortgage loans held for investment is impacted by the strength of the U.S. economy and local economic conditions, including residential housing prices. Economic trends that negatively affect housing prices and the job market could result in deterioration in credit quality of our mortgage loan portfolio and a decline in the value of associated collateral. Future interest rate resets could also lead to increased delinquencies in our mortgage loans held for investment.
Mortgage loans held by us are secured by properties concentrated in the states of Florida, New York, and California, which represented 19%, 23% and 11%, respectively, of total mortgage loans held for investment as of April 30, 2015. No other state held more than 10% of loan balances. If adverse trends in the residential mortgage loan market were to occur, particularly in geographic areas with a greater concentration of mortgage loans, we could incur loan loss provisions.
Mortgage loans purchased from Sand Canyon Corporation, previously known as Option One Mortgage Corporation (including its subsidiaries, collectively, SCC) represent 58% of total loans held for investment as of April 30, 2015. Remaining loans held for investment were originated by a third-party bank and purchased by us. Loans we purchased from SCC have experienced higher delinquency rates than other loans we purchased, and may expose us to greater risk of credit loss.
Mortgage loans held for investment had a carrying value of $239 million and a fair value of $190 million as of April 30, 2015. Although we have no current intent to do so, if we decide to sell these mortgage loans in the future we would incur an impairment loss for the difference between carrying value and fair value at the time of sale.
In addition to mortgage loans, we also extend secured and unsecured credit to other clients, including providing EAs to our tax clients. We may incur significant losses on credit we extend, which in turn could reduce our profitability.
Our business depends on our strong reputation and the value of our brands.
Developing and maintaining awareness of our brands is critical to achieving widespread acceptance of our existing and future services and products and is an important element in attracting new clients. In addition, our franchisees may operate their businesses under our brands. Adverse publicity (whether or not justified) relating to events or activities involving or attributed to us, our franchisees, employees, or agents or our services or products may tarnish our reputation and reduce the value of our brands. Damage to our reputation and loss of brand equity may reduce demand for our services and products and thus have an adverse effect on our future financial results, as well as require additional resources to rebuild our reputation and restore the value of our brands.
Failure to protect our intellectual property rights may harm our competitive position and litigation to protect our intellectual property rights or defend against third party allegations of infringement may be costly.
Despite our efforts to protect our intellectual property and proprietary information, we may be unable to do so effectively in all cases. Competitors may misappropriate our trademarks, copyrights or other intellectual property rights or duplicate our technology and products which may adversely affect our ability to compete with them. To the extent that our intellectual property is not protected effectively by trademarks, copyrights, patents, or other means, other parties with knowledge of our intellectual property, including former employees, may seek to exploit our intellectual property for their own or others' advantage. In addition, third-parties may allege we are infringing on their intellectual property rights, and we may face intellectual property challenges from other parties. We may not be successful in defending against any such challenges or in obtaining licenses to avoid or resolve any intellectual property disputes and, in that event, we could lose significant revenues, incur significant license, royalty, or technology development expenses, suffer harm to our reputation, or pay significant monetary damages.
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Failure to maintain sound business relationships with our franchisees may have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
Our financial success depends in significant part on our ability to maintain sound business relationships with our franchisees. The support of our franchisees is also critical for the success of our marketing programs and any new strategic initiatives we seek to undertake. Deterioration in our relationships with our franchisees or the failure of our franchisees to support our marketing programs and strategic initiatives could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
Our international operations are subject to risks which may harm our business and our consolidated financial position, results of operations, and cash flows.
We have international operations, including in Canada, Australia, India, and Brazil, and may consider expansion opportunities in additional countries in the future. There is uncertainty about our ability to generate revenues from new or emerging foreign operations and expand into other international markets. Additionally, there are risks inherent in doing business internationally, including: (1) changes in trade regulations; (2) difficulties in managing foreign operations as a result of distance, language, and cultural differences; (3) profit repatriation restrictions, and fluctuations in foreign currency exchange rates; (4) geopolitical events, including acts of war and terrorism, and economic and political instability; (5) compliance with U.S. laws such as the Foreign Corrupt Practices Act and other applicable foreign anti-corruption laws; (6) compliance with U.S. and international laws and regulations, including those concerning privacy, and data protection and retention; and (7) risks related to other government regulation or required compliance with local laws. These risks inherent in our international operations and expansion could increase our costs of doing business internationally and could have a material adverse effect on our business and our consolidated financial position, results of operations, and cash flows.
We may be adversely impacted by changes in corporate tax rates, the adoption of new tax legislation in the jurisdictions in which we operate, and exposure to additional tax liabilities.
As a multinational corporation, we are subject to taxes in the U.S. and numerous foreign jurisdictions where our subsidiaries are organized and conduct their operations. Significant judgment is required in determining our worldwide provision for income taxes and other tax liabilities. Tax rates in the various jurisdictions in which our subsidiaries are organized and conduct their operations may change significantly as a result of political or economic factors beyond our control. Additionally, our future effective tax rates could be adversely affected by changes in the valuation of deferred tax assets and liabilities or changes in tax laws or their interpretation. Our tax returns and other tax matters are periodically examined by tax authorities and governmental bodies, including the IRS, which may disagree with positions taken by us in determining our tax liability. There can be no assurance as to the outcome of these examinations. We regularly assess the likelihood of an adverse outcome resulting from these examinations to determine the adequacy of our provision for taxes. If our effective tax rates were to increase, or if the ultimate determination of our taxes owed is for an amount in excess of amounts previously accrued, our operating results, cash flows, and financial condition could be adversely affected.
RISKS RELATING TO DISCONTINUED OPERATIONS
SCC is subject to potential contingent losses related to representation and warranty claims, which may have an adverse effect on our business and our consolidated financial condition, results of operations, and cash flows. SCC has accrued an estimated liability related to these contingent losses that may not be adequate.
SCC remains exposed to losses relating to mortgage loans it previously originated. Mortgage loans originated by SCC were sold either as whole loans to single third-party buyers or in the form of residential mortgage-backed securities (RMBSs).
In connection with the sale of loans or RMBSs, SCC made certain representations and warranties. Claims under these representations and warranties together with any settlement arrangements related to these losses are collectively referred to as "representation and warranty claims." These representations and warranties varied based on the nature of the transaction and the buyer's or insurer's requirements, but generally pertained to the ownership of the loan, the validity of the lien securing the loan, borrower fraud, the loan's compliance with the criteria for inclusion in the transaction, including compliance with SCC's underwriting standards or loan criteria established by the buyer, ability to deliver required documentation, and compliance with applicable laws. Representations and
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warranties related to borrower fraud in whole loan sale transactions to institutional investors, which were generally securitized by such investors and represented approximately 68% of the disposal of loans originated in calendar years 2005, 2006 and 2007, included a "knowledge qualifier" limiting SCC's liability to those instances where SCC had knowledge of the fraud at the time the loans were sold. Representations and warranties made in other sale transactions effectively did not include a knowledge qualifier as to borrower fraud. SCC believes it would have an obligation to repurchase a loan only if it breached a representation and warranty and such breach materially and adversely affects the value of the mortgage loan or certificate holder's interest in the mortgage loan. SCC also would assert that it has no liability for the failure to repurchase any mortgage loan that has been liquidated prior to a repurchase demand, as described more fully in Item 8, note 18 to the consolidated financial statements
The statute of limitations for a contractual claim to enforce a representation and warranty obligation is generally six years or such shorter limitations period that may apply under the law of a state where the economic injury occurred. SCC believes that the limitations period begins to run from the applicable closing date of the sale of the loans or RMBS. On June 11, 2015, the New York Court of Appeals held in ACE Securities Corp. v. DB Structured Products, Inc., that the limitations period begins to run from the applicable closing date of the sale of the loans or RMBS. New York law governs many, though not all, of the transactions into which SCC entered. During fiscal years 2015, 2014, and 2013, SCC entered into tolling agreements with counterparties that have made a significant majority of previously denied representation and warranty claims. These tolling agreements toll the running of any applicable statute of limitations related to potential lawsuits regarding representation and warranty claims and other claims against SCC.
Development of loss estimates is subject to a high degree of management judgment and estimates may vary significantly period to period. SCC accrues a liability for losses related to representation and warranty claims when those losses are believed to be both probable and reasonably estimable. SCC has developed its estimate of losses related to representation and warranty claims based on the best information currently available, significant management judgment, and a number of factors that are subject to change, including developments in case law and the factors mentioned in Item 7, "Critical Accounting Estimates." Changes in any one of these factors could significantly impact the estimate.
SCC has accrued a liability as of April 30, 2015 for estimated contingent losses arising from representation and warranty claims of $149.8 million. If future losses are in excess of SCC's accrued liability, those losses could have a material adverse effect on our business and our consolidated financial position, results of operations and cash flows, as SCC's financial condition, results of operations and cash flows are included in our consolidated financial statements. The accrued liability does not include potential losses related to litigation matters discussed in the risk factor below and in Item 8, note 17 to the consolidated financial statements. Also see Item 8, note 18 to the consolidated financial statements.
SCC is subject to potential contingent losses related to securitization transactions in which SCC participated as a depositor or loan originator, which may result in significant financial losses.
Between January 2005 and November 2007, SCC originated mortgage loans totaling approximately $80 billion. Mortgage loans originated by SCC were sold either as whole loans to single third-party buyers, who generally securitized such loans, or in the form of RMBSs. SCC estimates approximately 90% of the loans it originated in 2005, 2006, and 2007 were securitized in approximately 110 securitization transactions. In most of these securitization transactions, SCC agreed, subject to certain conditions and limitations, to indemnify the underwriters or depositors for certain losses and expenses that the underwriters or depositors may incur as a result of certain claims made against them relating to loans originated by SCC, including certain legal expenses the underwriters or depositors incur in their defense of such claims. Some of those underwriters and depositors are defendants in lawsuits where various other parties allege a variety of claims, including violations of U.S. federal and state securities law and common law fraud based on alleged materially inaccurate or misleading disclosures, arising out of the activities of such underwriters or depositors in their sale of RMBSs or mortgage loans. Based on information currently available to SCC, it believes that the 20 lawsuits in which notice of a claim for indemnification has been made involve 39 securitization transactions with original investments of approximately $14 billion (of which the outstanding principal amount is approximately $4 billion). Certain of the notices received included, and future notices may include, a reservation of rights, which are referred to as "reserved contribution rights," that encompasses a right of contribution which may become operative if indemnification is unavailable or insufficient to cover all of the losses and expenses involved. Because SCC has not been a party to these lawsuits (with the exception of the Federal Home Loan Bank of Chicago v. Bank of America
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Funding Corporation case discussed in Item 8, note 17) and has not had control of this litigation or settlements thereof, SCC does not have precise information about the amount of damages or other remedies being asserted, the defenses to the claims in such lawsuits or the terms of any settlements of such lawsuits. SCC therefore cannot reasonably estimate the amount of potential losses or associated fees and expenses that may be incurred in connection with such lawsuits, which may be material. Additional lawsuits against the underwriters or depositors may be filed in the future, and SCC may receive additional notices of claims for indemnification or contribution from underwriters or depositors with respect to existing or new lawsuits or settlements of such lawsuits.
In addition, other counterparties to the securitization transactions, including certificate holders, securitization trustees and monoline insurance companies, have filed or may file lawsuits, or may assert indemnification claims, directly against depositors and loan originators in securitization transactions alleging a variety of claims, including U.S. federal and state securities law violations, common law torts and fraud and breach of contract claims, among others. Additional or new lawsuits or claims may be filed or asserted against SCC in the future.
These matters are in the early stages. We have not concluded that a loss related to any of these indemnification claims or reserved contribution rights is probable, have not accrued a liability for these claims or rights, and are not able to estimate a reasonably estimable possible loss or range of loss for these claims or rights. However, if SCC were required to pay material amounts with respect to these matters, it could have a material adverse effect on our business and our consolidated financial position, results of operations and cash flows, as SCC's financial condition, operating results, and cash flows are included in our consolidated financial statements. See Item 8, note 17 to the consolidated financial statements for additional information.
H&R Block has guaranteed the payment of certain limited claims against SCC.
SCC is subject to representation and warranty claims by counterparties to SCC whole loan sales and securitization transactions, including certificate holders, securitization trustees, monoline insurance companies, and subsequent purchasers of whole loans. In certain limited circumstances described below, H&R Block has outstanding guarantees of payment if claims are successfully asserted by such counterparties.
These guarantees include representation and warranty claims with respect to a limited number of whole loan sales by SCC with an aggregate outstanding principal and liquidated amount of approximately $1.4 billion as of January 31, 2013, based on the most recent data available to SCC from the servicer. There have been a total of approximately $41 million of representation and warranty claims with respect to these whole loan sales.
These guarantees also cover limited representation and warranty claims on other outstanding securitization transactions, with a potential claims exposure of less than $200 million. In addition, as is customary in divestiture transactions, H&R Block guaranteed the payment of any indemnification claims from the purchaser of SCC's servicing business, including claims relating to pre-closing services (which closing occurred in 2008).
We could be subject to claims by the creditors of SCC.
As discussed above, SCC is subject to representation and warranty claims and other claims and litigation related to its past sales and securitizations of mortgage loans. Additional claims and proceedings may be made in the future. If the amount that SCC is ultimately required to pay with respect to these claims and litigation, together with related administration and legal expense, exceeds its net assets, the creditors of SCC, or a bankruptcy trustee if SCC were to file or be forced into bankruptcy, may attempt to assert claims against us for payment of SCC's obligations. Claimants may also attempt to assert claims or seek payment directly from the Company even if SCC's assets exceed its liabilities. SCC's principal assets, as of April 30, 2015, total approximately $480 million and consist primarily of an intercompany note receivable and a deferred tax asset. We believe our legal position is strong on any potential corporate veil-piercing arguments; however, if this position is challenged and not upheld, it could have a material adverse effect on our business and our consolidated financial position, results of operations and cash flows. In addition, in certain limited instances, H&R Block guaranteed amounts as outlined in the above risk factor.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
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ITEM 2. PROPERTIES
Most of our tax offices are operated under leases or similar agreements throughout the U.S., Canada and Australia.
We own our corporate headquarters, which is located in Kansas City, Missouri, which is also where HRB Bank is headquartered and operates its single branch location. Our Canadian executive offices are located in a leased office in Calgary, Alberta. Our Australian executive offices are located in a leased office in Thornleigh, New South Wales.
All current leased and owned facilities are in reasonably good repair and adequate to meet our needs.
ITEM 3. LEGAL PROCEEDINGS
For a description of our material pending legal proceedings, see discussion in Item 8, note 17 to the consolidated financial statements.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
MARKET INFORMATION AND HOLDERS - H&R Block's common stock is traded on the New York Stock Exchange (NYSE) under the symbol HRB. On May 29, 2015, there were 18,789 shareholders of record and the closing stock price on the NYSE was $31.73 per share.
QUARTERLY STOCK PRICES AND DIVIDENDS - The quarterly information regarding H&R Block's common stock prices and dividends appears in Item 8, note 21 to the consolidated financial statements. Although we have historically paid dividends and plan to continue to do so, there can be no assurances that circumstances will not change in the future that could affect our ability or decisions to pay dividends. See note 19 to the consolidated financial statements for discussion of HRB Bank's ability to pay dividends.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS - The information called for by this item appearing in our definitive proxy statement under the heading "Equity Compensation Plans," to be filed no later than 120 days after April 30, 2015, is incorporated herein by reference.
A summary of our purchases of H&R Block common stock during the fourth quarter of fiscal year 2015 is as follows:
(in 000s, except per share amounts) | ||||||||||||||
Total Number of Shares Purchased (1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2) | Maximum Dollar Value of Shares that May be Purchased Under the Plans or Programs (2) | |||||||||||
February 1 – February 28 | 1 | $ | 34.28 | — | $ | 857,504 | ||||||||
March 1 – March 31 | 1 | $ | 34.07 | — | $ | 857,504 | ||||||||
April 1 – April 30 | 1 | $ | 32.29 | — | $ | 857,504 | ||||||||
3 | $ | 33.37 | ||||||||||||
(1) | We purchased approximately 3 thousand shares in connection with funding employee income tax withholding obligations arising upon the lapse of restrictions on restricted shares and restricted share units. There were no open-market repurchases. |
(2) | In June 2008, our Board of Directors approved an authorization to purchase up to $2.0 billion of our common stock through June 2012. In June 2012, our Board of Directors extended this authorization through June 2015. |
PERFORMANCE GRAPH – The following graph compares the cumulative five-year total return provided shareholders on H&R Block, Inc.'s common stock relative to the cumulative total returns of the S&P 500 index and a selected peer group. The peer group used is based on companies with similar market capitalization or public companies in the tax preparation industry.
An investment of $100, with reinvestment of all dividends, is assumed to have been made in our common stock and in each of the indexes on April 30, 2010, and its relative performance is tracked through April 30, 2015.
H&R Block, Inc. | 2015 Form 10-K | 23 |
Note: | The peer group includes the following companies: Intuit Inc., Blucora, Inc., Liberty Tax, Inc., CBIZ, Inc., Resources Connection, Inc., ICF International, Inc., Towers Watson & Co., Navigant Consulting, Inc., and Huron Consulting Group Inc. |
ITEM 6. SELECTED FINANCIAL DATA
We derived the selected consolidated financial data presented below from our audited consolidated financial statements as of and for each of the five annual periods ending April 30, 2015. Results of operations of fiscal years 2015, 2014 and 2013 are discussed in Item 7. The data set forth below should be read in conjunction with Item 7 and the consolidated financial statements in Item 8. During fiscal year 2012, we sold our previously reported Business Services segment and recorded a loss on the sale.
(in 000s, except per share amounts) | ||||||||||||||||||||
April 30, | 2015 | 2014 | 2013 | 2012 | 2011 | |||||||||||||||
Revenues | $ | 3,078,658 | $ | 3,024,295 | $ | 2,905,943 | $ | 2,893,771 | $ | 2,944,980 | ||||||||||
Net income from continuing operations | 486,744 | 500,097 | 465,158 | 345,968 | 392,547 | |||||||||||||||
Net income | 473,663 | 475,157 | 433,948 | 265,932 | 406,110 | |||||||||||||||
Basic earnings per share: | ||||||||||||||||||||
Continuing operations | $ | 1.77 | $ | 1.82 | $ | 1.70 | $ | 1.16 | $ | 1.27 | ||||||||||
Consolidated | 1.72 | 1.73 | 1.59 | 0.89 | 1.31 | |||||||||||||||
Diluted earnings per share: | ||||||||||||||||||||
Continuing operations | $ | 1.75 | $ | 1.81 | $ | 1.69 | $ | 1.16 | $ | 1.27 | ||||||||||
Consolidated | 1.71 | 1.72 | 1.58 | 0.89 | 1.31 | |||||||||||||||
Total assets | $ | 4,515,420 | $ | 4,693,529 | $ | 4,537,779 | $ | 4,649,567 | $ | 5,289,453 | ||||||||||
Long-term debt (1) | 506,088 | 906,474 | 906,680 | 1,040,549 | 1,040,084 | |||||||||||||||
Stockholders' equity | 1,832,949 | 1,556,549 | 1,263,547 | 1,325,892 | 1,449,574 | |||||||||||||||
Shares outstanding | 275,275 | 274,228 | 272,635 | 292,119 | 305,366 | |||||||||||||||
Dividends per share (2) | $ | 0.80 | $ | 0.80 | $ | 0.80 | $ | 0.70 | $ | 0.45 | ||||||||||
(1) | Includes current portion of long-term debt. |
(2) | Amounts represent dividends declared. In fiscal year 2011, a dividend of $0.15 per share paid in July 2010 was declared in April 2010. |
24 | 2015 Form 10-K | H&R Block, Inc. |
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our subsidiaries provide tax preparation, retail banking services and other services. Tax returns are either prepared by H&R Block tax professionals (in company-owned or franchise offices or virtually via the internet) or prepared and filed by our clients through H&R Block tax software, either online or using our desktop software or mobile applications.
RECENT DEVELOPMENTS
In April 2014, our subsidiaries, HRB Bank and Block Financial, entered into a P&A Agreement with BofI, which was amended in October 2014 and again in February 2015. Pursuant to the P&A Agreement, HRB Bank will sell certain assets and assign certain liabilities, including all of HRB Bank's deposit liabilities, to BofI, subject to various closing conditions, including the receipt of certain required approvals, entry into certain additional agreements, and the fulfillment of various other customary conditions. See Item 1 under "General Development of Business" and below under "Financial Condition - HRB Bank" for additional information.
Due to the lack of regulatory approval, we continued to offer financial services products to our clients through HRB Bank during the 2015 tax season.
The obligations of the parties to complete the P&A Transaction are subject to the fulfillment of numerous conditions including regulatory approval. We cannot be certain when or if the conditions to and other components of the P&A Transaction will be satisfied, or whether the P&A Transaction will be completed. In addition, there may be changes to the terms and conditions of the P&A Agreement and other contemplated agreements as part of the regulatory approval process.
In connection with additional agreements expected to be entered into upon the closing of the P&A Transaction, BofI will offer H&R Block-branded financial products distributed by the Company to the Company's clients. An operating subsidiary of the Company will provide certain marketing, servicing and operational support to BofI for such financial services and products. We expect the net, ongoing annual financial impact of these agreements to be dilutive by approximately $0.07 to $0.09 per share beginning in fiscal year 2016, based on current fully diluted shares outstanding. Results will vary based upon the volume of financial services products sold and the actual closing date.
H&R Block, Inc. became subject to the new SLHC regulatory capital requirements effective January 1, 2015. Until we divest HRB Bank and cease to be an SLHC, H&R Block, Inc. will remain subject to the minimum regulatory capital requirements which will likely restrict the capital allocation strategies available to us. See discussion in Item 1, "Regulation and Supervision – Bank and Holding Companies," and in Item 1A, "Risk Factors," for additional information on regulatory capital requirements for SLHCs.
OVERVIEW
A summary of our fiscal year 2015 results is as follows:
▪ | Tax Services' revenues increased $56.8 million, or 1.9%, compared to the prior year. U.S. assisted tax preparation fees increased $71.4 million, or 4.0%, while royalty revenues declined $23.4 million, or 7.4%, almost entirely due to acquisitions of franchisee businesses during the fiscal year. Return counts in our company-owned offices, excluding returns prepared in those offices acquired during fiscal year 2015, declined 4.6%. |
▪ | Pretax earnings fell $24.3 million, or 3.2%, as higher revenues were offset by increases in marketing and depreciation and amortization. |
▪ | Diluted earnings per share from continuing operations decreased 3.3% from the prior year to $1.75. |
▪ | Adjusted earnings from continuing operations before interest, taxes, depreciation and amortization (EBITDA) increased $18.7 million, or 2.0%, to $951.0 million. See "Non-GAAP Financial Information" at the end of this item for a reconciliation of non-GAAP measures. |
H&R Block, Inc. | 2015 Form 10-K | 25 |
RESULTS OF OPERATIONS
TAX SERVICES – This segment consists primarily of our assisted and DIY tax return preparation - in-person, online, desktop software and mobile applications - and related services to the general public primarily in the U.S. and its territories, Canada, and Australia. This segment also includes the activities of HRB Bank, which offers retail banking services, primarily in support of the U.S. tax business.
CORPORATE AND ELIMINATIONS – Corporate operating results include net interest income and gains or losses relating to mortgage loans held for investment and residual interests in securitizations, interest expense on borrowings, other corporate expenses, and eliminations of intercompany activities.
DISCONTINUED OPERATIONS – Discontinued operations include our previously reported Business Services segment and discontinued mortgage operations.
Tax Services – Operating Statistics | |||||||||
Year ended April 30, | 2015 | 2014 | 2013 | ||||||
TAX RETURNS PREPARED : (in 000s) | |||||||||
United States: | |||||||||
Company-owned operations | 8,327 | 8,342 | 8,907 | ||||||
Franchise operations | 4,688 | 5,268 | 5,598 | ||||||
Total assisted returns | 13,015 | 13,610 | 14,505 | ||||||
Desktop | 2,168 | 2,026 | 2,055 | ||||||
Online | 4,765 | 4,389 | 4,356 | ||||||
Free File Alliance | 676 | 767 | 663 | ||||||
Total tax software | 7,609 | 7,182 | 7,074 | ||||||
Total U.S. returns | 20,624 | 20,792 | 21,579 | ||||||
International operations: | |||||||||
Canada (1) | 2,658 | 2,642 | 2,517 | ||||||
Australia | 768 | 746 | 741 | ||||||
Other | 115 | 21 | 14 | ||||||
Total international operations | 3,541 | 3,409 | 3,272 | ||||||
Tax returns prepared worldwide | 24,165 | 24,201 | 24,851 | ||||||
TAX OFFICES (at the peak of the tax season): | |||||||||
U.S. offices: | |||||||||
Total company-owned offices | 6,365 | 6,086 | 6,211 | ||||||
Total franchise offices | 3,921 | 4,292 | 4,507 | ||||||
Total U.S. offices | 10,286 | 10,378 | 10,718 | ||||||
International offices: | |||||||||
Canada | 1,231 | 1,179 | 1,139 | ||||||
Australia | 433 | 409 | 410 | ||||||
Total international offices | 1,664 | 1,588 | 1,549 | ||||||
Tax offices worldwide | 11,950 | 11,966 | 12,267 | ||||||
(1) | In fiscal years 2015 and 2014, the end of the Canadian tax season was extended from April 30 to May 5. Tax returns prepared in Canada in fiscal years 2015 and 2014 includes approximately 131 thousand and 141 thousand returns, respectively, in both company-owned and franchise offices which were accepted by the client after April 30. The revenues related to these returns were recognized in fiscal years 2016 and 2015, respectively. |
26 | 2015 Form 10-K | H&R Block, Inc. |
Consolidated – Financial Results | (in 000s) | |||||||||||||||||||||||
Year ended April 30, | 2015 | 2014 | ||||||||||||||||||||||
Tax Services | Corporate and Eliminations | Total | Tax Services | Corporate and Eliminations | Total | |||||||||||||||||||
Tax preparation fees: | ||||||||||||||||||||||||
U.S. assisted | $ | 1,865,438 | $ | — | $ | 1,865,438 | $ | 1,794,043 | $ | — | $ | 1,794,043 | ||||||||||||
International | 207,772 | — | 207,772 | 200,152 | — | 200,152 | ||||||||||||||||||
U.S. DIY | 231,854 | — | 231,854 | 206,516 | — | 206,516 | ||||||||||||||||||
2,305,064 | — | 2,305,064 | 2,200,711 | — | 2,200,711 | |||||||||||||||||||
Royalties | 292,743 | — | 292,743 | 316,153 | — | 316,153 | ||||||||||||||||||
Revenues from refund transfers | 171,094 | — | 171,094 | 181,394 | — | 181,394 | ||||||||||||||||||
Revenues from Emerald Card® | 103,300 | — | 103,300 | 103,730 | — | 103,730 | ||||||||||||||||||
Revenues from Peace of Mind® Extended Service Plan | 81,551 | — | 81,551 | 89,685 | — | 89,685 | ||||||||||||||||||
Interest and fee income on Emerald Advance | 57,202 | — | 57,202 | 56,877 | — | 56,877 | ||||||||||||||||||
Other | 45,345 | 22,359 | 67,704 | 50,910 | 24,835 | 75,745 | ||||||||||||||||||
Total revenues | 3,056,299 | 22,359 | 3,078,658 | 2,999,460 | 24,835 | 3,024,295 | ||||||||||||||||||
Compensation and benefits: | ||||||||||||||||||||||||
Field wages | 731,309 | — | 731,309 | 702,312 | — | 702,312 | ||||||||||||||||||
Other wages | 158,463 | 18,234 | 176,697 | 169,583 | 22,997 | 192,580 | ||||||||||||||||||
Benefits and other compensation | 167,178 | 15,823 | 183,001 | 158,203 | 13,307 | 171,510 | ||||||||||||||||||
1,056,950 | 34,057 | 1,091,007 | 1,030,098 | 36,304 | 1,066,402 | |||||||||||||||||||
Occupancy and equipment | 375,392 | 351 | 375,743 | 363,590 | 1,446 | 365,036 | ||||||||||||||||||
Marketing and advertising | 271,866 | 1,816 | 273,682 | 237,214 | 1,549 | 238,763 | ||||||||||||||||||
Depreciation and amortization | 159,787 | 17 | 159,804 | 115,488 | 116 | 115,604 | ||||||||||||||||||
Bad debt | 75,003 | (10 | ) | 74,993 | 71,733 | 8,274 | 80,007 | |||||||||||||||||
Supplies | 42,808 | 64 | 42,872 | 36,454 | 73 | 36,527 | ||||||||||||||||||
Other | 242,054 | 23,837 | 265,891 | 260,676 | 42,790 | 303,466 | ||||||||||||||||||
Total operating expenses | 2,223,860 | 60,132 | 2,283,992 | 2,115,253 | 90,552 | 2,205,805 | ||||||||||||||||||
Other income | 799 | 515 | 1,314 | 10,664 | 25,651 | 36,315 | ||||||||||||||||||
Interest expense on borrowings | (2,067 | ) | (43,179 | ) | (45,246 | ) | (2,137 | ) | (53,142 | ) | (55,279 | ) | ||||||||||||
Other expenses | (7,935 | ) | 6 | (7,929 | ) | (26,367 | ) | (6,043 | ) | (32,410 | ) | |||||||||||||
Pretax income (loss) | $ | 823,236 | $ | (80,431 | ) | 742,805 | $ | 866,367 | $ | (99,251 | ) | $ | 767,116 | |||||||||||
Income taxes | 256,061 | 267,019 | ||||||||||||||||||||||
Net income from continuing operations | 486,744 | 500,097 | ||||||||||||||||||||||
Net loss from discontinued operations | (13,081 | ) | (24,940 | ) | ||||||||||||||||||||
Net income | $ | 473,663 | $ | 475,157 | ||||||||||||||||||||
Basic earnings (loss) per share: | ||||||||||||||||||||||||
Continuing operations | $ | 1.77 | $ | 1.82 | ||||||||||||||||||||
Discontinued operations | (0.05 | ) | (0.09 | ) | ||||||||||||||||||||
Consolidated | $ | 1.72 | $ | 1.73 | ||||||||||||||||||||
Diluted earnings (loss) per share: | ||||||||||||||||||||||||
Continuing operations | $ | 1.75 | $ | 1.81 | ||||||||||||||||||||
Discontinued operations | (0.04 | ) | (0.09 | ) | ||||||||||||||||||||
Consolidated | $ | 1.71 | $ | 1.72 | ||||||||||||||||||||
EBITDA from continuing operations (1) | $ | 948,537 | $ | 940,108 | ||||||||||||||||||||
EBITDA from continuing operations - adjusted (1) | 951,006 | 932,329 | ||||||||||||||||||||||
(1) | See "Non-GAAP Financial Information" at the end of this item for a reconciliation of non-GAAP measures. |
H&R Block, Inc. | 2015 Form 10-K | 27 |
FISCAL 2015 COMPARED TO FISCAL 2014
TAX SERVICES – Tax Services' revenues increased $56.8 million, or 1.9%, compared to the prior year. U.S. assisted tax preparation fees increased $71.4 million, or 4.0%, while royalty revenues declined $23.4 million, or 7.4%, almost entirely due to acquisitions of franchisee businesses during the fiscal year. Return counts in our company-owned offices, excluding returns prepared in those offices acquired during fiscal year 2015, declined 4.6%.
International tax preparation fees increased $7.6 million, or 3.8%, due primarily to pricing changes, partially offset by unfavorable exchange rates.
Tax preparation fees from our U.S. DIY business increased $25.3 million, or 12.3%, primarily due to an 8.1% increase in paid returns. The remaining increase is due to better monetization of new and existing clients and a higher number of more complicated returns.
Fees earned on RTs decreased $10.3 million, or 5.7%, primarily due to lower assisted return volumes.
Revenue from fees for our POM is initially deferred, and recognized over the term of the service plan based on actual claims paid in relation to projected claims. Revenue decreased $8.1 million, or 9.1%, in fiscal year 2015 primarily due to a change in projected claims that resulted in an increase in revenue recognized last year.
Total expenses increased $108.6 million, or 5.1%, from the prior year. Total compensation and benefits increased $26.9 million primarily due to higher variable field wages resulting from increased revenues and increased training costs. Occupancy and equipment expenses increased $11.8 million, or 3.2%, primarily due to a 4.6% increase in company-owned offices resulting from franchise acquisitions. Marketing and advertising expenses increased $34.7 million due to a planned increase in national advertising spend as part of our current year marketing strategy. Depreciation and amortization expense increased $44.3 million, or 38.4%, primarily due to acquisitions of franchisee and competitor businesses and improvements to existing offices. Other expenses decreased $18.6 million, or 7.1%, primarily due to lower litigation and consulting costs in the current year.
Other income declined $9.9 million primarily due to a $10.1 million gain on the sale of an intangible customer list asset in the prior year. Other expenses declined $18.4 million, primarily due to an other-than-temporary impairment on AFS securities of $12.4 million recorded in the prior year, coupled with a decline of $6.7 million in foreign currency losses.
Pretax income for fiscal year 2015 decreased $43.1 million, or 5.0%, over the prior year. The pretax margin for the segment decreased to 26.9% in fiscal year 2015 from 28.9% in fiscal year 2014.
CORPORATE – Bad debt expense declined $8.3 million from the prior year due to improved collateral values. Other operating expenses decreased $19.0 million, or 44.3%, primarily due to declines in litigation, insurance, consulting and loan servicing costs.
Other income declined $25.1 million, primarily due to a gain of $18.3 million recognized in fiscal year 2014 on the sale of residual interests in mortgage securitizations. Interest expense declined $10.0 million, or 18.7%, due to repayment of our notes that matured in October 2014. Other expenses declined $6.0 million primarily due to lower foreign currency losses.
DISCONTINUED OPERATIONS – The net loss from our discontinued operations totaled $13.1 million for the current year, compared to a net loss of $24.9 million in the prior year.
Pretax losses of mortgage operations totaled $27.1 million, compared to $38.5 million in the prior year, and resulted primarily from loss provisions related to SCC's estimated contingent losses for representation and warranty claims of $16.0 million and $25.0 million for fiscal years 2015 and 2014, respectively.
Our discontinued Business Services segment also recorded favorable adjustments resulting in an improvement of $7.5 million in legal settlements during fiscal year 2015 over the prior year.
28 | 2015 Form 10-K | H&R Block, Inc. |
Consolidated – Financial Results | (in 000s) | |||||||||||||||||||||||
Year ended April 30, | 2014 | 2013 | ||||||||||||||||||||||
Tax Services | Corporate and Eliminations | Total | Tax Services | Corporate and Eliminations | Total | |||||||||||||||||||
Tax preparation fees: | ||||||||||||||||||||||||
U.S. assisted | $ | 1,794,043 | $ | — | $ | 1,794,043 | $ | 1,712,319 | $ | — | $ | 1,712,319 | ||||||||||||
International | 200,152 | — | 200,152 | 220,870 | — | 220,870 | ||||||||||||||||||
U.S. DIY | 206,516 | — | 206,516 | 189,341 | — | 189,341 | ||||||||||||||||||
2,200,711 | — | 2,200,711 | 2,122,530 | — | 2,122,530 | |||||||||||||||||||
Royalties | 316,153 | — | 316,153 | 318,386 | — | 318,386 | ||||||||||||||||||
Revenues from refund transfers | 181,394 | — | 181,394 | 158,176 | — | 158,176 | ||||||||||||||||||
Revenues from Emerald Card® | 103,730 | — | 103,730 | 98,896 | — | 98,896 | ||||||||||||||||||
Revenues from Peace of Mind® Extended Service Plan | 89,685 | — | 89,685 | 71,355 | — | 71,355 | ||||||||||||||||||
Interest and fee income on Emerald Advance | 56,877 | — | 56,877 | 59,657 | — | 59,657 | ||||||||||||||||||
Other | 50,910 | 24,835 | 75,745 | 48,967 | 27,976 | 76,943 | ||||||||||||||||||
Total revenues | 2,999,460 | 24,835 | 3,024,295 | 2,877,967 | 27,976 | 2,905,943 | ||||||||||||||||||
Compensation and benefits: | ||||||||||||||||||||||||
Field wages | 702,312 | — | 702,312 | 654,794 | — | 654,794 | ||||||||||||||||||
Other wages | 169,583 | 22,997 | 192,580 | 150,306 | 19,030 | 169,336 | ||||||||||||||||||
Benefits and other compensation | 158,203 | 13,307 | 171,510 | 148,492 | 10,526 | 159,018 | ||||||||||||||||||
1,030,098 | 36,304 | 1,066,402 | 953,592 | 29,556 | 983,148 | |||||||||||||||||||
Occupancy and equipment | 363,590 | 1,446 | 365,036 | 354,430 | 308 | 354,738 | ||||||||||||||||||
Marketing and advertising | 237,214 | 1,549 | 238,763 | 270,240 | 543 | 270,783 | ||||||||||||||||||
Depreciation and amortization | 115,488 | 116 | 115,604 | 92,004 | 403 | 92,407 | ||||||||||||||||||
Bad debt | 71,733 | 8,274 | 80,007 | 77,402 | 13,283 | 90,685 | ||||||||||||||||||
Supplies | 36,454 | 73 | 36,527 | 40,131 | 70 | 40,201 | ||||||||||||||||||
Other | 260,676 | 42,790 | 303,466 | 268,034 | 34,964 | 302,998 | ||||||||||||||||||
Total operating expenses | 2,115,253 | 90,552 | 2,205,805 | 2,055,833 | 79,127 | 2,134,960 | ||||||||||||||||||
Other income | 10,664 | 25,651 | 36,315 | 2,142 | 10,433 | 12,575 | ||||||||||||||||||
Interest expense on borrowings | (2,137 | ) | (53,142 | ) | (55,279 | ) | (2,172 | ) | (72,125 | ) | (74,297 | ) | ||||||||||||
Other expenses | (26,367 | ) | (6,043 | ) | (32,410 | ) | (961 | ) | (6,289 | ) | (7,250 | ) | ||||||||||||
Pretax income (loss) | $ | 866,367 | $ | (99,251 | ) | 767,116 | $ | 821,143 | $ | (119,132 | ) | $ | 702,011 | |||||||||||
Income taxes | 267,019 | 236,853 | ||||||||||||||||||||||
Net income from continuing operations | 500,097 | 465,158 | ||||||||||||||||||||||
Net loss from discontinued operations | (24,940 | ) | (31,210 | ) | ||||||||||||||||||||
Net income | $ | 475,157 | $ | 433,948 | ||||||||||||||||||||
Basic earnings (loss) per share: | ||||||||||||||||||||||||
Continuing operations | $ | 1.82 | $ | 1.70 | ||||||||||||||||||||
Discontinued operations | (0.09 | ) | (0.11 | ) | ||||||||||||||||||||
Consolidated | $ | 1.73 | $ | 1.59 | ||||||||||||||||||||
Diluted earnings (loss) per share: | ||||||||||||||||||||||||
Continuing operations | $ | 1.81 | $ | 1.69 | ||||||||||||||||||||
Discontinued operations | (0.09 | ) | (0.11 | ) | ||||||||||||||||||||
Consolidated | $ | 1.72 | $ | 1.58 | ||||||||||||||||||||
EBITDA from continuing operations (1) | $ | 940,108 | $ | 874,375 | ||||||||||||||||||||
EBITDA from continuing operations - adjusted (1) | 932,329 | 884,245 | ||||||||||||||||||||||
(1) | See "Non-GAAP Financial Information" at the end of this item for a reconciliation of non-GAAP measures. |
H&R Block, Inc. | 2015 Form 10-K | 29 |
FISCAL 2014 COMPARED TO FISCAL 2013
TAX SERVICES – Tax Services' revenues increased $121.5 million, or 4.2%, compared to the prior year primarily due to an increase in U.S. tax preparation fees of $81.7 million, or 4.8%. Elimination in virtually all markets of a prior year offer to prepare certain 1040EZ tax returns at no charge (resulting in a one-time increase of over $30 million), a shift to more complex returns, and other pricing changes resulted in higher revenues. Other pricing changes primarily related to targeted changes to our pricing strategy for a limited number of clients who were receiving significant discounts and beginning to charge for tax return extensions. This increase was partially offset by a 6.3% decline in returns prepared driven primarily by our decision to discontinue the free 1040EZ offer.
International tax preparation fees decreased $20.7 million, or 9.4%, due primarily to unfavorable exchange rates and extension of the Canadian tax season to May 5th.
U.S. DIY revenue increased $17.2 million, or 9.1%, primarily due to tax software product enhancements and monetization efforts.
Fees earned on RTs increased $23.2 million, or 14.7%, primarily due to elimination of certain price discounts and higher volumes for our online clients.
POM revenue increased in fiscal year 2014 primarily due to improving claim experience and lower estimates of projected claims.
Total expenses increased $59.4 million, or 2.9%, from the prior year. Total compensation and benefits increased $76.5 million primarily due to higher variable field wages resulting from increased revenues and increases to in-office customer service support staff. Occupancy and equipment expenses increased $9.2 million, or 2.6%, primarily due to a 4.8% increase in company-owned offices. Marketing and advertising expenses declined $33.0 million due to a planned reduction in national advertising spend. Depreciation and amortization expense increased $23.5 million, or 25.5%, primarily due to office upgrades and competitor acquisitions. Other expenses decreased $7.4 million, or 2.7%, primarily due to declines in POM and related claims, partially offset by higher consulting and travel costs.
Other income increased $8.5 million primarily due to a $10.1 million gain on the sale of an intangible customer list asset. Other expenses increased $25.4 million, primarily due to an other-than-temporary impairment on AFS securities of $12.4 million, coupled with an increase of $12.8 million in foreign currency losses.
Pretax income for fiscal year 2014 increased $45.2 million, or 5.5%, over the prior year. The pretax margin for the segment increased to 28.9% in fiscal year 2014 from 28.5% in fiscal year 2013.
CORPORATE – Interest expense declined $19.0 million, or 26.3%, due to lower interest rates on our long-term debt, coupled with lower principal balances outstanding. Other expenses increased $7.8 million, or 22.4%, primarily due to higher consulting and insurance expenses.
Other income increased $15.2 million, primarily due to a gain of $18.3 million recognized on the sale of residual interests in mortgage securitizations, partially offset by lower accretion on those residuals. Other expenses were essentially flat as higher foreign currency losses in fiscal year 2014 were offset by the loss on extinguishment of debt recorded in fiscal year 2013.
DISCONTINUED OPERATIONS – The net loss from our discontinued operations totaled $24.9 million for fiscal year 2014, compared to a net loss of $31.2 million in fiscal year 2013.
Pretax losses of mortgage operations totaled $38.5 million, compared to $52.1 million in fiscal year 2013, and resulted primarily from loss provisions related to SCC's estimated contingent losses for representation and warranty claims of $25.0 million and $40.0 million for fiscal years 2014 and 2013, respectively.
CONTINGENT LOSSES – SCC has accrued a liability as of April 30, 2015 for estimated contingent losses arising from representation and warranty claims of $149.8 million. The estimate of accrued loss is based on the best information currently available, significant management judgment, and a number of factors that are subject to change, including developments in case law and the factors, mentioned in "Critical Accounting Estimates" below. Changes in any one of these factors could significantly impact the estimate.
Losses may also be incurred with respect to various indemnification claims or reserved contribution rights by underwriters and depositors in securitization transactions in which SCC participated. SCC has not concluded that a
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loss is probable or reasonably estimable related to these indemnification claims or reserved contribution rights, therefore there is no accrued liability for these contingent losses as of April 30, 2015.
See additional discussion in Item 1A, "Risk Factors," "Critical Accounting Estimates" below and in Item 8, note 18 to the consolidated financial statements.
CRITICAL ACCOUNTING ESTIMATES
We consider the estimates discussed below to be critical to understanding our financial statements, as they require the use of significant judgment and estimation in order to measure, at a specific point in time, matters that are inherently uncertain. Specific methods and assumptions for these critical accounting estimates are described in the following paragraphs. We have reviewed and discussed each of these estimates with the Audit Committee of our Board of Directors. For all of these estimates, we caution that future events rarely develop precisely as forecasted and estimates routinely require adjustment and may require material adjustment.
See Item 8, note 1 to the consolidated financial statements, which discusses accounting policies we have selected when there are acceptable alternatives and new or proposed accounting standards that may affect our financial reporting in the future.
LOSSES ARISING FROM REPRESENTATIONS AND WARRANTIES –
Nature of Estimates Required. SCC accrues a liability for losses related to representation and warranty claims when those losses are believed to be both probable and reasonably estimable. Development of loss estimates is subject to significant management judgment, and estimates may vary significantly period to period.
Assumptions and Approach Used. SCC has entered into tolling agreements with counterparties that have made a significant majority of previously denied representation and warranty claims. These tolling agreements toll the running of any applicable statute of limitations related to potential lawsuits regarding representation and warranty claims and other claims against SCC.
Beginning in the fourth quarter of fiscal year 2013 and continuing through fiscal year 2015, SCC has been engaged in discussions with these counterparties regarding the bulk settlement of previously denied and potential future claims. Based on settlement discussions with certain counterparties, SCC believes a bulk settlement approach, rather than the loan-by-loan resolution process, will be needed to resolve all of the representation and warranty and other claims that are the subject of these discussions. On December 5, 2014, SCC entered into a settlement agreement to resolve certain of these claims. The amount paid under the settlement agreement was fully covered by prior accruals. In the event that the ongoing efforts to settle are not successful, SCC believes claim volumes may increase or litigation may result.
SCC will continue to vigorously contest any request for repurchase when it has concluded that a valid basis for repurchase does not exist. SCC's decision whether to engage in bulk settlement discussions is based on factors that vary by counterparty or type of counterparty and include the considerations (described below) used by SCC in determining its loss estimate.
SCC's loss estimate for representation and warranty claims is based on the best information currently available, significant management judgment, and a number of factors that are subject to change, including developments in case law and the factors mentioned below. These factors include the terms of SCC's prior bulk settlements, the terms expected to result from ongoing bulk settlement discussions, and an assessment of, among other things, historical claim results, threatened claims, terms and provisions of related agreements, counterparty willingness to pursue a settlement, legal standing of counterparties to provide a comprehensive settlement, bulk settlement methodologies used and publicly disclosed by other market participants, the potential pro-rata realization of the claims as compared to all claims and other relevant facts and circumstances when developing its estimate of probable loss. SCC believes that the most significant of these factors are the terms expected to result from ongoing bulk settlement discussions, which have been primarily influenced by the bulk settlement methodologies used and publicly disclosed by other market participants and the anticipated pro-rata realization of the claims of particular counterparties as compared to the anticipated realization if all claims and litigation were resolved together with payment of SCC's related administration and legal expense. Changes in any one of the factors mentioned above could significantly impact the estimate.
H&R Block, Inc. | 2015 Form 10-K | 31 |
Sensitivity of Estimate to Change. It is reasonably possible that future representation and warranty losses may vary from the amounts accrued for these exposures. SCC currently believes the aggregate range of reasonably possible losses in excess of amounts accrued is not material. This estimated range is based on the best information currently available, significant management judgment and a number of factors that are subject to change, including developments in case law and the factors listed above. The actual loss that may be incurred could differ materially from our accrual or the estimate of reasonably possible losses.
SCC has accrued a liability as of April 30, 2015 for estimated contingent losses arising from representation and warranty claims of $149.8 million. SCC accrued incremental loss provisions of $16 million in fiscal year 2015, $25 million in fiscal year 2014 and $40 million in fiscal year 2013.
If the amount that SCC is ultimately required to pay with respect to claims and litigation related to its past sales and securitizations of mortgage loans, together with payment of SCC's related administration and legal expense, exceeds SCC's net assets, the creditors of SCC, or a bankruptcy trustee if SCC were to file or be forced into bankruptcy, may attempt to assert claims against us for payment of SCC's obligations. Claimants may also attempt to assert claims or seek payment directly from the Company even if SCC's assets exceed its liabilities. SCC's principal assets, as of April 30, 2015, total approximately $480 million and consist primarily of an intercompany note receivable and a deferred tax asset. We believe our legal position is strong on any potential corporate veil-piercing arguments; however, if this position is challenged and not upheld, it could have a material adverse effect on our business and our consolidated financial position, results of operations and cash flows.
The accrued liability does not include potential losses related to litigation and indemnification matters discussed in Item 1A, "Risk Factors" and in Item 8, note 17 to the consolidated financial statements. Also see Item 8, note 18 to the consolidated financial statements.
LITIGATION AND RELATED CONTINGENCIES –
Nature of Estimates Required. We accrue liabilities related to certain legal matters for which we believe it is probable that a loss has been incurred and the amount of such loss can be reasonably estimated. Assessing the likely outcome of pending or threatened litigation, including the amount of potential loss, if any, is highly subjective.
Assumptions and Approach Used. We are subject to pending or threatened litigation claims and indemnification claims, which are described in Item 8, note 17 to the consolidated financial statements. It is our policy to routinely assess the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses. A determination of the amount of the liability required to be accrued, if any, for these contingencies is made after analysis of each known issue and an analysis of historical experience. In cases where we have concluded that a loss is only reasonably possible or remote, or is not reasonably estimable, no liability is accrued.
Sensitivity of Estimate to Change. It is reasonably possible that future litigation and related contingent losses may vary from the amounts accrued. For some matters where a liability has not been accrued, we are able to estimate a reasonably possible loss or range of loss. Those matters for which an estimate is not reasonably possible are not included within this estimated range. Therefore, this estimated range of reasonably possible loss represents what we believe to be an estimate of reasonably possible loss only for certain matters meeting these criteria. It does not represent our maximum loss exposure. For those matters, and for matters where a liability has been accrued, as of April 30, 2015, we believe the aggregate range of reasonably possible losses in excess of amounts accrued is not material. However, our judgments on whether a loss is probable, reasonably possible or remote and our estimates of probable loss amounts may differ from actual results due to difficulties in predicting the outcome of jury trials, arbitration hearings, settlement discussions and related activity, predicting the outcome of class certification actions and numerous other uncertainties. Due to the number of claims which are periodically asserted against us, and the magnitude of damages sought in those claims, actual losses in the future may significantly differ from our current estimates.
INCOME TAXES – UNCERTAIN TAX POSITIONS –
Nature of Estimates Required. The income tax laws of jurisdictions in which we operate are complex and subject to different interpretations by the taxpayer and applicable government taxing authorities. Income tax returns filed by us are based on our interpretation of these rules. The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which may result in proposed assessments, including assessments of interest
32 | 2015 Form 10-K | H&R Block, Inc. |
or penalties. We have accrued a liability for uncertain tax positions that reflects our judgment as to the ultimate resolution of the applicable issues if subject to judicial review or other settlement.
Assumptions and Approach Used. We evaluate each uncertain tax position based on its technical merits. If we determine it is more likely than not a tax position will be sustained based on its technical merits, we record the impact of the position in our consolidated financial statements at the largest amount that is greater than fifty percent likely of being realized upon ultimate settlement. We do not record a tax benefit for tax positions where we have concluded it is not more likely than not to be sustained. Differences between a tax position taken or expected to be taken in our tax returns and the amount of benefit recognized and measured in the financial statements result in unrecognized tax benefits, which are recorded in the balance sheet as either a liability for unrecognized tax benefits or reductions to recorded tax assets, as applicable.
Sensitivity of Estimate to Change. Our assessment of the technical merits and measurement of tax benefits associated with uncertain tax positions is subject to a high degree of judgment and estimation. Actual results may differ from our current judgments due to a variety of factors, including changes in law, interpretations of law by taxing authorities that differ from our assessments, changes in the jurisdictions in which we operate and results of routine tax examinations. We believe we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, or when statutes of limitation on potential assessments expire. As a result, our effective tax rate may fluctuate on a quarterly basis.
As of April 30, 2015, we accrued liabilities for unrecognized tax benefits on uncertain tax positions of approximately $86 million. Of the total gross unrecognized tax benefit as of April 30, 2015, approximately $55 million would impact our effective tax rate if ultimately recognized.
INCOME TAXES – VALUATION OF DEFERRED TAX ASSETS –
Nature of Estimates Required. We account for income taxes under the asset and liability method, which requires us to record deferred income tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying value of existing assets and liabilities and their respective tax basis. Deferred taxes are determined separately for each tax-paying component within each tax jurisdiction based on provisions of enacted tax law.
We record a valuation allowance to reduce our deferred tax assets to the estimated amount that we believe is more likely than not to be realized. Determination of a valuation allowance for deferred tax assets requires that we make judgments about future matters that are not certain, including projections of future taxable income and evaluating potential tax-planning strategies.
Assumptions and Approach Used. Our deferred tax assets include state and foreign tax loss carry-forwards, which in some cases have been reduced by a valuation allowance. We have considered taxable income in carry-back periods, historical and forecasted earnings, future taxable income, the mix of earnings in the jurisdictions in which we operate, and tax planning strategies in determining the need for a valuation allowance and the estimated amount of these deferred tax assets that will more likely than not be realized.
Sensitivity of Estimate to Change. To the extent that actual results differ from our current assumptions, valuation allowances for deferred tax assets will increase or decrease. In the event we determine that we could not realize all or part of our deferred tax assets in the future, an adjustment would be charged to earnings in the period in which we make such determination. Likewise, if we later determine it is more likely than not that we could realize the deferred tax assets, we would reverse the applicable portion of the previously provided valuation allowance.
As of April 30, 2015, valuation allowances for our deferred tax assets totaled $25 million. As a result of changes in deferred tax valuation allowances, our effective tax rate increased 0.2% and 1.5% in fiscal years 2015 and 2014, respectively.
NEW ACCOUNTING PRONOUNCEMENTS
See Item 8, note 1 to the consolidated financial statements for a discussion of recently issued accounting pronouncements.
H&R Block, Inc. | 2015 Form 10-K | 33 |
FINANCIAL CONDITION
These comments should be read in conjunction with the consolidated balance sheets and consolidated statements of cash flows included in Item 8.
CAPITAL RESOURCES AND LIQUIDITY –
OVERVIEW – Our primary sources of capital and liquidity include cash from operations (including changes in working capital) and issuances of debt. We use our sources of liquidity primarily to fund working capital, service and repay debt, pay dividends, repurchase shares of our common stock, and acquire businesses.
Our operations are highly seasonal and substantially all of our revenues and cash flow are generated during the period from January through April. Therefore, we require the use of cash to fund losses from May through December, and typically rely on available cash balances from the prior tax season and short-term borrowings to meet our off-season liquidity needs.
Given the likely availability of a number of liquidity options discussed herein, including borrowing capacity under the 2012 CLOC and the issuance of commercial paper, we believe that, in the absence of any unexpected developments, our existing sources of capital as of April 30, 2015 are sufficient to meet our operating and financing needs.
DISCUSSION OF CONSOLIDATED STATEMENTS OF CASH FLOWS – The following table summarizes our statements of cash flows for fiscal years 2015, 2014 and 2013. See Item 8 for the complete consolidated statements of cash flows for these periods.
(in 000s) | ||||||||||||
Year ended April 30, | 2015 | 2014 | 2013 | |||||||||
Net cash provided by (used in): | ||||||||||||
Operating activities | $ | 626,608 | $ | 809,581 | $ | 497,108 | ||||||
Investing activities | (148,932 | ) | 10,690 | (110,937 | ) | |||||||
Financing activities | (645,807 | ) | (364,930 | ) | (584,541 | ) | ||||||
Effects of exchange rate changes on cash | (9,986 | ) | (17,618 | ) | 1,620 | |||||||
Net change in cash and cash equivalents | $ | (178,117 | ) | $ | 437,723 | $ | (196,750 | ) | ||||
Cash from Operating Activities. Cash provided by operations, which consists primarily of cash received from customers, declined $183.0 million from fiscal year 2014. The decrease from the prior year was primarily due to an increase in income tax payments of $80.9 million and a $50.0 million settlement payment related to representations and warranties.
Cash from Investing Activities. Cash used in investing activities totaled $148.9 million compared to cash provided of $10.7 million in the prior year primarily due to proceeds received in fiscal year 2014 totaling $64.9 million from full repayment of principal and accrued interest outstanding on notes receivable in connection with the sale of RSM McGladrey, an increase in purchases of available-for-sale (AFS) securities of $45.4 million, and an increase in payments for business acquisitions of $44.8 million.
Cash from Financing Activities. Cash used in financing activities increased $280.9 million primarily due to the repayment of $400.0 million in 5.125% Senior Notes which matured in October 2014. This was partially offset by a reduction in cash used to fund customer deposit balances.
CASH REQUIREMENTS –
Dividends and Share Repurchase. Returning capital to shareholders in the form of dividends and the repurchase of outstanding shares has historically been a significant component of our capital allocation plan.
We have consistently paid quarterly dividends. Dividends paid totaled $220.0 million, $219.0 million and $217.2 million in fiscal years 2015, 2014 and 2013, respectively. Although we have historically paid dividends and plan to continue to do so, there can be no assurances that circumstances will not change in the future that could affect our ability or decisions to pay dividends.
Although we completed no open-market repurchases of outstanding shares of our common stock in fiscal years 2015 or 2014, we did repurchase 21.3 million shares at a cost of $315.0 million in fiscal year 2013.
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We currently have Board of Directors' authorization to purchase up to $2.0 billion of our common stock through June 2015. There was $857.5 million remaining under this authorization as of April 30, 2015. Although we have historically from time to time repurchased common stock, there can be no assurances that circumstances will allow us to continue to repurchase common stock in the future. As long as we remain subject to regulatory supervision of the Federal Reserve, our share repurchase program will be closely supervised and we will likely be restricted from repurchasing outstanding shares.
HRB Bank. In April 2014, we entered into the P&A Agreement with BofI, which was amended in October 2014 and again in February 2015. The P&A Agreement is subject to various closing conditions, including the receipt of certain required approvals, entry into certain additional agreements, and the fulfillment of various other customary conditions. If the closing conditions (including regulatory approvals) are satisfied, we will complete a closing of the P&A Transaction, including the sale of certain assets and transfer of certain liabilities (principally deposit liabilities) to BofI.
Due to the lack of regulatory approval, we continued to offer financial services products to our clients through HRB Bank during the 2015 tax season.
Upon the closing of the P&A Transaction, we will make a cash payment to BofI for the difference in the carrying value of assets sold and the carrying value of liabilities (including deposit liabilities) transferred. The amount of the cash payment made at closing will primarily be equal to the carrying value of the liabilities to be transferred since the carrying value of the assets to be transferred is immaterial. Pursuant to the February Letter Agreement, the parties have set the date of closing as June 30, 2015, unless otherwise agreed by the parties. As of the date of this filing, the parties have not received formal regulatory approval and, as a result, the parties do not expect to close the P&A Transaction on the previously contemplated June 30, 2015 date. Due to the seasonality of our business, the timing of any closing of the P&A Transaction will impact the amount of deposit liabilities transferred. During fiscal year 2015, our deposit balances ranged from approximately $440 million to approximately $1.7 billion. In connection with the closing we intend to liquidate the available-for-sale (AFS) securities held by HRB Bank, which totaled $435 million at April 30, 2015.
See additional discussion in Item 1, under "Business," and in Item 8, note 2 to the consolidated financial statements. See additional discussion of regulatory and capital requirements of HRB Bank in Item 1, "Regulation and Supervision - Bank and Holding Companies," and Item 1A, "Risk Factors."
Capital Investment. Our business is not capital intensive. Capital expenditures totaled $123.2 million and $147.0 million in fiscal years 2015 and 2014, respectively. Our capital expenditures relate primarily to recurring improvements to retail offices, as well as investments in computers, software and related assets. We expended net cash totaling $113.3 million and $68.4 million in fiscal years 2015 and 2014 in connection with acquired businesses. We routinely acquire competitor tax businesses and franchisees, and recurring capital allocated to acquisitions consists primarily of this activity. In fiscal year 2014, we also acquired the assets, primarily purchased technology, of a business for $30.3 million.
FINANCING RESOURCES – Our 2012 CLOC has capacity up to $1.5 billion and is scheduled to expire in August 2017. See additional discussion, including a description of related covenants, in Item 8, note 10 to the consolidated financial statements.
While we use commercial paper borrowings to fund our seasonal working capital needs, we had no commercial paper borrowings outstanding as of April 30, 2015 or 2014. Our commercial paper borrowings peaked at $718.6 million in January 2015.
We also had $400.0 million in 5.125% Senior Notes which matured in October 2014 and, utilizing cash on hand, we repaid them according to their terms. During fiscal year 2013, we issued $500.0 million in 5.50% Senior Notes, the proceeds of which, together with cash balances on hand, were used to redeem $600.0 million of our 7.875% Senior Notes that were due to mature in January 2013.
H&R Block, Inc. | 2015 Form 10-K | 35 |
The following table provides ratings for debt issued by Block Financial as of April 30, 2015 and 2014:
Short-term | Long-term | Outlook | ||||
Moody's | P-2 | Baa2 | Stable | |||
S&P | A-2 | BBB | Negative | |||
CASH AND INVESTMENT SECURITIES – As of April 30, 2015, we held cash and cash equivalents of $2.0 billion, including $474.9 million held by HRB Bank and $155.5 million held by our foreign subsidiaries.
Dividends of cash balances held by HRB Bank would be subject to regulatory approval and are therefore not available for general corporate purposes. HRB Bank received regulatory approval and subsequently paid cash dividends and returned capital of $250.0 million during fiscal year 2015. HRB Bank did not pay any dividends during fiscal years 2014 or 2013.
As of April 30, 2015, we also held investments, primarily mortgage backed securities, with a carrying value of $441.7 million which we classified as available for sale. As discussed above, it is our intent (subject to market conditions) to liquidate the majority of these securities in connection with a closing of the P&A Transaction.
Foreign Operations. Seasonal borrowing needs of our Canadian operations are typically funded by our U.S. operations. To mitigate foreign currency exchange rate risk, in fiscal years 2015 and 2014 we entered into foreign exchange forward contracts. There were no forward contracts outstanding as of April 30, 2015.
As of April 30, 2015, our Canadian operations had approximately $52 million of U.S. dollar denominated borrowings owed to various U.S. subsidiaries. These borrowings may be repaid in full or in part at any time. Non-borrowed funds would have to be repatriated to be available to fund domestic operations, and in certain circumstances this would trigger additional income taxes on those amounts. We do not currently intend to repatriate any non-borrowed funds held by our foreign subsidiaries.
The impact of changes in foreign exchange rates during the period on our international cash balances resulted in a decrease of $10.0 million during fiscal year 2015 compared to a decrease of $17.6 million and an increase of $1.6 million in fiscal years 2014 and 2013, respectively. This change resulted primarily from a decline in Canadian exchange rates.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS – A summary of our obligations to make future payments as of April 30, 2015, is as follows:
(in 000s) | ||||||||||||||||||||
Total | Less Than 1 Year | 1 - 3 Years | 4 - 5 Years | After 5 Years | ||||||||||||||||
Long-term debt (including interest) | $ | 717,436 | $ | 27,500 | $ | 55,000 | $ | 55,000 | $ | 579,936 | ||||||||||
Customer deposits (including interest) | 745,242 | 744,772 | 462 | 8 | — | |||||||||||||||
Contingent acquisition payments | 10,667 | 8,746 | 1,921 | — | — | |||||||||||||||
Capital lease obligations | 8,194 | 790 | 1,807 | 2,100 | 3,497 | |||||||||||||||
Operating leases | 548,364 | 197,199 | 246,128 | 94,325 | 10,712 | |||||||||||||||
Total contractual cash obligations | $ | 2,029,903 | $ | 979,007 | $ | 305,318 | $ | 151,433 | $ | 594,145 | ||||||||||
The table above does not reflect unrecognized tax benefits of approximately $86 million due to the high degree of uncertainty regarding the future cash flows associated with these amounts.
See discussion of contractual obligations and commitments in Item 8, within the notes to the consolidated financial statements.
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REGULATORY ENVIRONMENT – H&R Block, Inc. became subject to the new SLHC regulatory capital requirements, effective January 1, 2015. Until we divest HRB Bank and cease to be an SLHC, H&R Block, Inc. will remain subject to the minimum regulatory capital requirements which will likely restrict the capital allocation strategies available to us. See discussion in Item 1, "Regulation and Supervision - Bank and Holding Companies," Item 1A, "Risk Factors," and Item 8, note 19 for additional information on regulatory capital requirements for SLHCs.
The federal government, various state, local, provincial and foreign governments, and some self-regulatory organizations have enacted statutes and ordinances, or adopted rules and regulations, regulating aspects of our business. These aspects include, but are not limited to, commercial income tax return preparers, income tax courses, the electronic filing of income tax returns, the offering of RTs, loan originations and assistance in loan originations, mortgage lending, privacy, consumer protection, franchising, sales methods and banking. We determine the applicability of such statutes, ordinances, rules and regulations (collectively, Laws) and work to comply with those Laws that are applicable to us or our services or products.
From time to time in the ordinary course of business, we receive inquiries from governmental and self-regulatory agencies regarding the applicability of Laws to our services and products. In response to past inquiries, we have demonstrated that we comply with such Laws, convinced the authorities that such Laws were not applicable or that compliance already exists, or modified our activities in the applicable jurisdiction to avoid the application of all or certain parts of such Laws. We believe the past resolution of such inquiries and our ongoing compliance with Laws has not had a material effect on our consolidated financial statements. We cannot predict what effect future Laws, changes in interpretations of existing Laws or the results of future regulatory inquiries with respect to the applicability of Laws may have on our consolidated financial position, results of operations and cash flows. See additional discussion of legal matters in Item 8, note 17 to the consolidated financial statements.
NON-GAAP FINANCIAL INFORMATION
Non-GAAP financial measures should not be considered as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP. Because these measures are not measures of financial performance under GAAP and are susceptible to varying calculations, they may not be comparable to similarly titled measures for other companies.
We consider non-GAAP financial measures to be a useful metric for management and investors to evaluate and compare the ongoing operating performance of our business on a consistent basis across reporting periods, as it eliminates the effect of items that are not indicative of our core operating performance.
The following are descriptions of adjustments we make for our non-GAAP financial measures:
▪ | We exclude losses from settlements and estimated contingent losses from litigation and favorable reserve adjustments. This does not include legal defense costs. |
▪ | We exclude non-cash charges to adjust the carrying values of goodwill, intangible assets, other long-lived assets and investments to their estimated fair values. |
▪ | We exclude severance and other restructuring charges in connection with the termination of personnel, closure of offices and related costs. |
▪ | We exclude the gains and losses on business dispositions, including investment banking, legal and accounting fees from both business dispositions and acquisitions. |
▪ | We exclude the gains and losses on extinguishment of debt. |
We may consider whether other significant items that arise in the future should also be excluded from our non-GAAP financial measures.
We measure the performance of our business using a variety of metrics, including EBITDA, adjusted EBITDA and adjusted income of continuing operations. Adjusted EBITDA and adjusted income eliminate the impact of items that we do not consider indicative of our core operating performance and, we believe, provide meaningful information to assist in understanding our financial results, analyzing trends in our underlying business, and assessing our prospects for future performance. We also use EBITDA and income of continuing operations, each subject to permitted adjustments, as performance metrics in incentive compensation calculations for our employees.
H&R Block, Inc. | 2015 Form 10-K | 37 |
We no longer include adjustments for discrete tax items in reporting our non-GAAP measures, which more closely aligns with our internal calculations and analyses. Non-GAAP measures previously reported in fiscal years 2014 and 2013 have been restated to conform to our current reporting practice.
The following is a reconciliation of our reported results from continuing operations and to our adjusted results from continuing operations:
(in 000s, except per share amounts) | ||||||||||||||||||||||||
Year ended April 30, | 2015 | 2014 | 2013 | |||||||||||||||||||||
EBITDA | Income | EBITDA | Income | EBITDA | Income | |||||||||||||||||||
As reported - from continuing operations | $ | 948,537 | $ | 486,744 | $ | 940,108 | $ | 500,097 | $ | 874,375 | $ | 465,158 | ||||||||||||
Adjustments (pretax): | ||||||||||||||||||||||||
Loss contingencies - litigation | (3,936 | ) | (3,936 | ) | 1,844 | 1,844 | (4,579 | |||||||||||||||||