DBRS Confirms H&R Block at BBB (high), Trend Revised to Positive

DBRS has today confirmed all ratings of H&R Block, Inc. (Block or the Company) and its subsidiaries, Block Financial Corporation and H&R Block Canada, Inc. including its long-term ratings of BBB (high) and short-term ratings of R-2 (high). Concurrently, the trend on all ratings has been revised to Positive from Stable.

Today’s rating action considers the successful progress that the Company has made in reducing its risk profile and Block’s renewed focus on its solid cash-flow generating core tax business. In DBRS’s opinion, Block’s recent exit from the mortgage business and the pending sale of its Financial Advisors segment not only reduces the capital needs of the Company, but importantly, allows the Company to fully utilize its strong cash flows to support its tax franchise.

Block’s strong franchise strength and leading market position, its significant cash flow generating ability and the robust earnings generation powers of the core tax preparation business underpin the ratings. Further, DBRS considers Block’s ability to produce significant revenues with a high level of predictability as a fundamental strength of the Company. However, revenue and earnings are also highly 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 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. As such, DBRS does not consider the first quarter of fiscal 2009 loss of $133 million as an indication of the full year results.

The current ratings are mindful of the reduced level of equity. Block’s equity base declined from $2.1 billion in 2006 to $988 million at April 30, 2008. Although, DBRS views Block’s ongoing need for capital as reduced given the exit from its most capital intensive business, Option One Mortgage Co. (OOMC), and the pending sale of Financial Advisors. DBRS expects that Block will replenish its equity base through increased earnings retention which bodes well for a stronger, more stable balance sheet. However, the high level of goodwill and other intangibles reduces equity on a tangible basis.

DBRS views positively Block’s newly-appointed management team’s focus on growing and defending the dominant position of its core tax business, which DBRS considers Block’s chief challenge. In addition, to the fierce competition in the retail tax preparation business, digital tax preparation continues to grow in popularity, therefore DBRS views Block’s success in growing its share of the digital tax preparation market another key challenge.

The Positive trend reflects DBRS’s opinion that the Company has clearly illustrated solid momentum in its core business, in its realignment efforts and in its focus on removing costs. Although the management team is new to Block and has yet to demonstrate a long-term track record, the recent results of its strategic plans have been well executed. Further, the Positive trend reflects DBRS anticipation that the Company will be rebuilding its capital position before returning to stock repurchasing, which is key to upward rating migration. Moreover, in addition to a successful sale of Financial Advisors, positive ratings actions are subject to continued solid liquidity and no material additional increases in representations and warranties risk from previously sold mortgage assets.

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