H&R Block Shares Fall; Sees Wider Loss Ahead

H&R Block, slammed over the past year by exposure to risky mortgages, reported a bigger-than-expected quarterly loss Tuesday after shutting down its Option One Mortgage subprime lender.

H&R Block
H&R Block

The net worth of the No. 1 U.S. tax preparer has plummeted in recent months, potentially putting H&R Block in violation of bank covenants, said Kathleen Shanley, an analyst at GimmeCredit, an independent fixed-income research firm.

H&R Block said the results for the second quarter that ended Oct. 31 were preliminary as it had to delay the official release of its financial report after hiring a new accounting firm, Deloitte & Touche LLP, late in the period.

"The delay is convenient for (H&R Block) because it gives the company a few more days to figure out what to say about the fact that it is evidently in violation of its bank covenants," Shanley said in a research note. "The company's bank credit lines require it to maintain an adjusted net worth of at least $650 million."

The company said shareholders' equity, or net worth, in H&R Block now stands at $544.3 million, down from $1.4 billion at the end of April.

The company also said fiscal 2008 earnings would come in toward the lower end of its previous outlook of $1.35 to $1.45 per share from continuing operations because of higher borrowing costs. The company's stock was down 1.7 percent at $19.62 in morning trade on the New York Stock Exchange.

Executives said they were working on realigning the cost structure at what will be a smaller company without Option One.

During the first two quarters of fiscal 2008, H&R Block burned through nearly $535 million, according to a preliminary cash flow statement. So far, net cash used in operating activities has been $942.1 million.

That leaves H&R Block with $387 million in cash and cash equivalents, down from $922 million six months ago, the company said.

The past month has been a tumultuous one for the Kansas City, Missouri-based company. Mark Ernst resigned as chairman and chief executive in late November. Richard C. Breeden, who leads an investment fund that is a major investor, was elected chairman after pushing for sweeping changes.

Then on Dec. 4, H&R Block said a deal for Cerberus Capital Management to buy Option One had collapsed, leading to the shutdown of the subprime lender. Escalating subprime mortgage defaults throughout the United States have torn up a lending industry that relaxed standards to expand the market of making loans to people with weak credit.

Preliminary results show H&R Block's second-quarter net loss from continuing operations widening to $136.1 million, or 42 cents a share, from $121 million, or 38 cents a share, a year earlier. On that basis, analysts on average were expecting a loss of 35 cents a share, according to Reuters Estimates.

The company said it typically lost money in its fiscal first and second quarters because of the seasonality of its tax and business services.

Including discontinued operations, H&R Block expects its second-quarter net loss to widen to $502.3 million, or $1.55 per share, from $156.5 million, or 49 cents per share.

The results include a loss of $366.2 million, or $1.13 per share, from discontinued operations. Much of that consists of a $252 million net loss on the sale of $3 billion in whole mortgage loans by the company or related mortgage trusts.

"While we incurred a painful loss in exiting these positions, we determined to take our lumps and move forward," Breeden said in a statement.

At Monday's close, the company's stock had fallen 13 percent this year.

The company's shares and reputation have been battered as a 10-year foray into mortgages backfired and ultimately resulted in the ouster of Ernst.

As part of shuttering Option One, H&R Block said last week that it would cease making loans and fire more than 600 people after an April deal to sell the unit to Cerberus fell apart.

Meanwhile, H&R Block said second-quarter revenue from continuing operations rose 10 percent to $434.8 million. But surging operating costs more than offset that gain.

For fiscal 2007, H&R Block and its subsidiaries reported $4 billion in revenue and $374.3 million in net income from continuing operations.