DBRS Confirms H&R Block, Inc. Issuer Rating at BBB (high), Trend Positive

DBRS has today confirmed the ratings of H&R Block, Inc. and its subsidiaries (Block or the Company), including its BBB (high) Issuer Rating. The trend on all ratings remains Positive. The ratings consider Block’s strong franchise and leading market position, its significant cash flow generating ability, the robust and predictable earnings generation power of the core tax preparation business and the low financial risk profile.

Further, DBRS considers Block’s ability to produce sizeable revenues with a high level of predictability as a fundamental strength of the Company. Block’s revenue and earnings are seasonal, attributed to the annual business cycle of the core Tax Services segment and, to a lesser extent, its Business Services segment. The seasonality causes Block to typically operate at a loss for the first three quarters of the fiscal year and a significant gain for the last quarter of the fiscal year.

The ratings also consider the substantial reduction in the Company’s financial risk profile and the Company’s renewed focus on its solid cash-flow generating, low-risk core tax business. In DBRS’s opinion, Block’s exit from the mortgage business and the sale of its Financial Advisors segment not only lowered the capital needs of the Company and removed earnings volatility, importantly, the simplification of the Company’s business model allows management to focus it attention on the core tax business.

The current ratings consider the improved equity base. The Company as expected has rebuilt its equity base which was eroded by losses generated in the now-discontinued mortgage operation. Furthermore, as discussed above, capital needs have been reduced by the business disposals. At fiscal year end, April 30, 2009, Block’s total equity had increased 42% to $1.4 billion and tangible equity had increased to $170 million from $9 million a year ago.

Despite the small decline in tax returns prepared, Block’s franchise remains very strong. During tax season 2009, H&R Block’s U.S. tax returns prepared declined 3.2% to 21.1 million. As a result, Block’s tax returns prepared represented 15.8% of an IRS estimate of individual tax returns filed by April 30, 2009, a 40 basis point decline from tax season 2008. Reversing the trajectory of tax returns prepared is a key challenge for the Company during the upcoming tax season. DBRS views positively Block’s relatively new management team’s focus on leveraging the strong awareness of the Block brand to grow and defend the dominant position of its core tax business. In addition to the competition in the retail tax preparation business, digital tax preparation continues to grow in popularity; therefore, DBRS views Block’s ability to leverage its strong brand and take advantage of the growth opportunities afforded by the digital tax preparation market as another key challenge.

DBRS maintains the Positive trend reflecting the opinion that the Company continues to illustrate solid progress in strengthening and de-risking the balance sheet. Upward ratings migration is contingent on Block maintaining these trends along with a solid annual performance for the current fiscal year. Ongoing positive momentum in the tax business is certainly crucial to a rating upgrade. Moreover, positive ratings actions are subject to continued solid liquidity, no material additional increases in representations and warranties risk from previously sold mortgage assets and no sizeable goodwill impairment charges should the alternative practice structure agreement with McGladrey & Pullen (M&P) be terminated.

Note:
All figures are in U.S. dollars unless otherwise noted.

The applicable rating methodology is Rating Finance Companies Operating in the United States, which can be found on our website under methodologies.

This is a Corporate (Financial Institutions) rating.