|• FORM 10-Q • AMENDED AND RESTATED BYLAWS • FIRST AMENDMENT TO CREDIT AGREEMENT • FORM OF INDEMNIFICATION AGREEMENT, AND SCHEDULE OF PARTIES • CERTIFICATION BY CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 • CERTIFICATION BY CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 • CERTIFICATION BY CHIEF EXECUTIVE OFFICER FURNISHED PURSUANT TO SECTION 906 • CERTIFICATION BY CHIEF FINANCIAL OFFICER FURNISHED PURSUANT TO SECTION 906 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE • XBRL TAXONOMY EXTENSION LABEL LINKBASE • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended January 31, 2012
For the transition period from to
Commission file number 1-6089
H&R Block, Inc.
(Exact name of registrant as specified in its charter)
One H&R Block Way
Kansas City, Missouri 64105
(Address of principal executive offices, including zip code)
(Registrants telephone number, including area code)
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 Ö No
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 Ö 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 the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one) :
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No Ö
The number of shares outstanding of the registrants Common Stock, without par value, at the close of business on February 29, 2012 was 293,563,719 shares.
Form 10-Q for the Period Ended January 31, 2012
See Notes to Condensed Consolidated Financial Statements
See Notes to Condensed Consolidated Financial Statements
See Notes to Condensed Consolidated Financial Statements
Basis of Presentation
The condensed consolidated balance sheet as of January 31, 2012, the condensed consolidated statements of operations and comprehensive income (loss) for the three and nine months ended January 31, 2012 and 2011, and the condensed consolidated statements of cash flows for the nine months ended January 31, 2012 and 2011 have been prepared by the Company, without audit. In the opinion of management, all adjustments, which include only normal recurring adjustments, necessary to present fairly the financial position, results of operations and cash flows at January 31, 2012 and for all periods presented have been made. See below for discussion of our presentation of discontinued operations.
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.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in our April 30, 2011 Annual Report to Shareholders on Form 10-K. All amounts presented herein as of April 30, 2011 or for the year then ended, are derived from our April 30, 2011 Annual Report to Shareholders on Form 10-K.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates, assumptions and judgments are applied in the determination of our allowance for loan losses, potential losses from loan repurchase and indemnity obligations associated with our discontinued mortgage business, contingent losses associated with pending claims and litigation, fair value of reporting units, valuation allowances based on future taxable income, reserves for uncertain tax positions, credit losses on receivable balances and related matters. Estimates have been prepared on the basis of the most current and best information available as of each balance sheet date. As such, actual results could differ materially from those estimates.
Seasonality of Business
Our operating revenues are seasonal in nature with peak revenues occurring in the months of January through April. Therefore, results for interim periods are not indicative of results to be expected for the full year.
Discontinued Operations Recent Events
In November 2011, we sold substantially all assets of RSM McGladrey, Inc. (RSM) to McGladrey & Pullen LLP (M&P) for net cash proceeds of $495.6 million. We also received a short-term note in the amount of $32.3 million and a long-term note in the amount of $54.0 million. M&P assumed substantially all liabilities of RSM, including contingent payments and lease obligations. We have indemnified M&P for certain litigation matters as discussed in note 13. The net after tax loss on the sale of RSM totaled $37.1 million, which includes an $85.4 million impairment of goodwill recorded in our first quarter and tax benefits of $20.5 million recorded in the third quarter associated with capital loss carry-forwards utilized.
In the first quarter, we also announced we were evaluating strategic alternatives for RSM EquiCo, Inc. (EquiCo), and effective January 31, 2012, we sold the assets of EquiCos subsidiary, McGladrey Capital Markets LLC (MCM), for cash proceeds of $1.0 million. We have indemnified the buyer for certain litigation matters related to this business. The net after tax loss on the sale of MCM totaled $12.4 million and included a $14.3 million impairment of goodwill recorded in our first quarter. The remaining EquiCo businesses will be wound down.
As of January 31, 2012, the results of operations of these businesses are presented as discontinued operations in the condensed consolidated financial statements. All periods presented in our condensed consolidated balance sheets and statements of operations have been reclassified to reflect our discontinued operations. See additional information in note 13.
Basic and diluted loss per share is computed using the two-class method. The two-class method is an earnings allocation formula that determines net income per share for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Per share amounts are computed by dividing net income from continuing operations attributable to common shareholders by the weighted average shares outstanding during each period. The dilutive effect of potential common shares is included in diluted earnings per share except in those periods with a loss from continuing operations. Diluted earnings per share excludes the impact of shares of common stock issuable upon the lapse of certain restrictions or the exercise of options to purchase 9.6 million shares for the three and nine months ended January 31, 2012, and 12.6 million shares for the three and nine months ended January 31, 2011, as the effect would be antidilutive due to the net loss from continuing operations during each period.
The computations of basic and diluted loss per share from continuing operations are as follows:
The weighted average shares outstanding for the three and nine months ended January 31, 2012 decreased to 293.0 million and 299.5 million, respectively, from 305.1 million and 310.5 million for the three and nine months ended January 31, 2011, respectively, primarily due to share repurchases completed in the current fiscal year. During the nine months ended January 31, 2012, we purchased and immediately retired 13.0 million shares of our common stock at a cost of $177.5 million. The cost of shares retired during the current period was allocated to the components of stockholders equity as follows:
During the nine months ended January 31, 2011, we purchased and immediately retired 19.0 million shares of our common stock at a cost of $279.9 million.
In addition to the shares we repurchased as described above, during the nine months ended January 31, 2012, we acquired 0.2 million shares of our common stock at an aggregate cost of $3.1 million. These shares represent shares swapped or surrendered to us in connection with the vesting of nonvested shares
and the exercise of stock options. During the nine months ended January 31, 2011, we acquired 0.2 million shares at an aggregate cost of $3.5 million for similar purposes.
During the nine months ended January 31, 2012 and 2011, we issued 1.0 million and 1.1 million shares of common stock, respectively, due to the exercise of stock options, employee stock purchases and vesting of nonvested shares.
During the nine months ended January 31, 2012, we granted 2.4 million stock options and 1.0 million nonvested shares and units under our stock-based compensation plans. The weighted average fair value of options granted was $3.36 for management options. These awards typically vest over a three year period with one-third vesting each year. Stock-based compensation expense of our continuing operations totaled $2.0 million and $11.0 million for the three and nine months ended January 31, 2012, respectively, and $3.5 million and $7.3 million for the three and nine months ended January 31, 2011, respectively. At January 31, 2012, unrecognized compensation cost for options totaled $7.5 million, and for nonvested shares and units totaled $16.5 million.
Short-term receivables of our continuing operations consist of the following:
As discussed in note 1, we have a short-term receivable for $32.3 million and a long-term note receivable in the amount of $54.0 million due from M&P related to the sale of RSM. The short-term receivable note is based on the final post-closing adjustments to the purchase price we expect to receive. The long-term note is unsecured and bears interest at a rate of 8.0%, with all principal and accrued interest due in May 2017. As of January 31, 2012, there is no allowance recorded related to the short-term receivable or the long-term note, however we will monitor publicly available information relevant to the financial condition of M&P to assess future collectability. The long-term note is included in other assets in our condensed consolidated balance sheet.
The short-term portion of Emerald Advance lines of credit (EAs), tax client receivables related to refund anticipation loans (RALs) and loans made to franchisees is included in receivables, while the long-term portion is included in other assets in the condensed consolidated financial statements. These amounts are as follows:
We review the credit quality of our EA receivables and tax client receivables related to RALs based on pools, which are segregated by the year of origination, with older years being deemed more unlikely to be repaid. These amounts as of January 31, 2012, by year of origination, are as follows:
As of January 31, 2012 and April 30, 2011, $41.4 million and $46.8 million, respectively, of EAs were on non-accrual status and classified as impaired, or more than 60 days past due. All tax client receivables related to RALs are considered impaired.
Loans made to franchisees totaled $215.6 million at January 31, 2012, and consisted of $150.4 million in term loans made to finance the purchase of franchises and $65.2 million in revolving lines of credit made to existing franchisees primarily for the purpose of funding their off-season needs.
Activity in the allowance for doubtful accounts for the nine months ended January 31, 2012 and 2011 is as follows:
There were no changes to our methodology related to the calculation of our allowance for doubtful accounts during the nine months ended January 31, 2012.
The composition of our mortgage loan portfolio as of January 31, 2012 and April 30, 2011 is as follows:
Our loan loss allowance as a percent of mortgage loans was 17.4% at January 31, 2012, compared to 16.1% at April 30, 2011.
Activity in the allowance for loan losses for the nine months ended January 31, 2012 and 2011 is as follows:
When determining our allowance for loan losses, we evaluate loans less than 60 days past due on a pooled basis, while loans we consider impaired, including those loans more than 60 days past due or modified as troubled debt restructurings (TDRs), are evaluated individually. The balance of these loans and the related allowance is as follows:
Our portfolio includes loans originated by Sand Canyon Corporation, previously known as Option One Mortgage Corporation, and its subsidiaries (SCC) and purchased by H&R Block Bank (HRB Bank), which constitute 63% of the total loan portfolio at January 31, 2012. We have experienced higher rates of delinquency and believe that we have greater exposure to loss with respect to this segment of our loan portfolio. Our remaining loan portfolio totaled $192.4 million and is characteristic of a prime loan portfolio, and we believe therefore subject to a lower loss exposure. Detail of our mortgage loans held for investment and the related allowance at January 31, 2012 is as follows:
Credit quality indicators at January 31, 2012 include the following:
Loans given our internal risk rating of high were generally originated by SCC, have no documentation or are stated income and are non-owner occupied. Loans given our internal risk rating of medium were generally full documentation or stated income, with loan-to-value at origination of more than 80% and
have credit scores at origination below 700. Loans given our internal risk rating of low were generally full documentation, with loan-to-value at origination of less than 80% and have credit scores greater than 700.
Our mortgage loans held for investment include concentrations of loans to borrowers in certain states, which may result in increased exposure to loss as a result of changes in real estate values and underlying economic or market conditions related to a particular geographical location. Approximately 52% of our mortgage loan portfolio consists of loans to borrowers located in the states of Florida, California and New York.
Detail of the aging of the mortgage loans in our portfolio that are past due as of January 31, 2012 is as follows:
Information related to our non-accrual loans is as follows:
Information related to impaired loans is as follows:
Information related to the allowance for impaired loans is as follows:
Information related to activities of our non-performing assets is as follows:
Our real estate owned (REO) includes loans accounted for as in-substance foreclosures of $5.7 million and $7.7 million at January 31, 2012 and April 30, 2011, respectively. Activity related to our REO is as follows:
The amortized cost and fair value of securities classified as available-for-sale (AFS) held at January 31, 2012 and April 30, 2011 are summarized below:
We did not record any other-than-temporary impairments of AFS securities during the three or nine months ended January 31, 2012. During the three and nine months ended January 31, 2011, we recorded other-than-temporary impairments of AFS securities totaling $1.5 million and $1.9 million, respectively, as a result of an assessment that it was probable we would not collect all amounts due or an assessment that we would not be able to hold the investments until potential recovery of market value.
Contractual maturities of AFS debt securities at January 31, 2012, occur at varying dates over the next 30 years, and are set forth in the table below.
We use the following valuation methodologies for assets and liabilities measured at fair value and the general classification of these instruments pursuant to the fair value hierarchy.
The following table presents for each hierarchy level the assets that were remeasured at fair value on both a recurring and non-recurring basis during the nine months ended January 31, 2012 and 2011 and the gains (losses) on those remeasurements:
There were no changes to the unobservable inputs used in determining the fair values of our level 2 and level 3 financial assets.
The following methods were used to determine the fair values of our other financial instruments:
The carrying amounts and estimated fair values of our financial instruments at January 31, 2012 are as follows:
Changes in the carrying amount of the goodwill of our continuing operations for the nine months ended January 31, 2012 consist of the following:
In the current year, we discontinued service under our ExpressTax brand. As a result, we recorded an impairment of the reporting units goodwill, which totaled $4.3 million.
We test goodwill and other indefinite-life intangible assets for impairment annually or more frequently if events occur or circumstances change which would, more likely than not, reduce the fair value of a reporting unit below its carrying value.
Intangible assets of our continuing operations consist of the following:
Amortization of intangible assets of our continuing operations for the three and nine months ended January 31, 2012 was $4.7 and $15.2 million, respectively. Additionally, we recorded an impairment of customer relationships of $4.0 million, related to the discontinuation of our ExpressTax brand, as discussed above. Amortization of intangible assets of our continuing operations for the three and nine months ended January 31, 2011 was $4.5 and $12.8 million, respectively. Estimated amortization of
intangible assets for fiscal years 2012 through 2016 is $17.7 million, $16.5 million, $14.6 million, $11.3 million and $10.7 million, respectively.
Borrowings consist of the following:
We had commercial paper borrowings of $230.9 million at January 31, 2012, compared to $632.6 million at the same time last year. These borrowings were used to fund our off-season losses and cover our seasonal working capital needs.
As of January 31, 2012, our $600.0 million Senior Notes are included in current portion of long-term debt in our condensed consolidated balance sheet due to their contractual maturity in January 2013.
At January 31, 2012, we maintained a committed line of credit (CLOC) agreement to support commercial paper issuances, general corporate purposes or for working capital needs. This facility provides funding up to $1.7 billion and matures July 31, 2013. This facility bears interest at an annual rate of LIBOR plus 1.30% to 2.80% or PRIME plus 0.30% to 1.80% (depending on the type of borrowing) and includes an annual facility fee of 0.20% to 0.70% of the committed amounts (based on our credit ratings). Covenants in this facility include: (1) maintenance of a minimum equity of $650.0 million on the last day of any fiscal quarter; and (2) reduction of the aggregate outstanding principal amount of short-term debt, as defined in the CLOC agreement, to $200.0 million or less for thirty consecutive days during the period March 1 to June 30 of each year. At January 31, 2012, we were in compliance with these covenants and had net worth of $806.4 million. We had no balance outstanding under the CLOC at January 31, 2012. Effective March 2, 2012, we amended our CLOC agreement to reduce the amount of minimum equity that we must maintain as of the last day of any fiscal quarter from $650.0 million to $500.0 million.
HRB Bank is a member of the FHLB of Des Moines, which extends credit to member banks based on eligible collateral. At January 31, 2012, HRB Bank had total FHLB advance capacity of $284.2 million. There was $25.0 million outstanding on this facility, leaving remaining availability of $259.2 million. Mortgage loans held for investment of $372.7 million serve as eligible collateral and are used to determine total capacity.
We file a consolidated federal income tax return in the United States and file tax returns in various state and foreign jurisdictions. The U.S. Federal consolidated tax returns for the years 1999 through 2010 are currently under examination by the Internal Revenue Service, with the 1999-2007 years currently at the appellate level. Federal returns for tax years prior to 1999 are closed by statute. Historically, tax returns in various foreign and state jurisdictions are examined and settled upon completion of the exam.
We had gross unrecognized tax benefits of $199.2 million and $154.8 million at January 31, 2012 and April 30, 2011, respectively. The gross unrecognized tax benefits increased $44.4 million net in the current year, due primarily to accruals of tax on positions related to current and prior years partially offset by statute of limitations expirations and settlements with taxing authorities. A majority of the tax expense related to the increase in unrecognized benefits is recorded in discontinued operations as it relates to
operations that have been discontinued and/or disposed. Except as noted below, we have classified the liability for unrecognized tax benefits, including corresponding accrued interest, as long-term at January 31, 2012, and included this amount in other noncurrent liabilities on the condensed consolidated balance sheet.
Based upon the expiration of statutes of limitations, payments of tax and other factors in several jurisdictions, we believe it is reasonably possible that the gross amount of reserves for previously unrecognized tax benefits may decrease by approximately $3.5 million within the twelve month period after January 31, 2012. This portion of our liability for unrecognized tax benefits has been classified as current and is included in accounts payable, accrued expenses and other current liabilities on the condensed consolidated balance sheets.
The following table shows the components of interest income and expense of our continuing operations:
HRB Bank historically filed its regulatory Thrift Financial Report (TFR) on a calendar quarter basis with the Office of Thrift Supervision (OTS). In July 2011, as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Reform Act), the responsibility and authority of the OTS moved to the Office of the Comptroller of the Currency (OCC). HRB Bank filed its TFRs with the OCC through December 31, 2011. Beginning March 31, 2012, HRB Bank will file Reports of Condition and Income (Call Report) with the OCC quarterly. Additionally, H&R Block, Inc. as the bank holding company is now regulated by the Federal Reserve Bank and, as such, is subject to certain reporting requirements.
The following table sets forth HRB Banks regulatory capital requirements, as calculated in its TFR:
Block Financial LLC (BFC) typically makes capital contributions to HRB Bank to help it meet its capital requirements. BFC made capital contributions to HRB Bank of $200.0 million during the nine months ended January 31, 2012, with an additional $200.0 million contributed in February 2012.
As of January 31, 2012, HRB Banks leverage ratio was 27.1%.
Changes in deferred revenue balances related to our Peace of Mind (POM) program, the current portion of which is included in accounts payable, accrued expenses and other current liabilities and the long-term portion of which is included in other noncurrent liabilities in the condensed consolidated balance sheets, are as follows:
In addition to amounts accrued for our POM guarantee, we had accrued $12.5 million and $14.7 million at January 31, 2012 and April 30, 2011, respectively, related to our standard guarantee which is included with our standard tax preparation services.
The following table summarizes certain of our other contractual obligations and commitments:
We have recorded liabilities totaling $8.2 million and $11.0 million as of January 31, 2012 and April 30, 2011, respectively, in conjunction with contingent payments related to recent acquisitions of our continuing operations, with the short-term amount recorded in accounts payable, accrued expenses and
deposits and the long-term portion included in other noncurrent liabilities. Our estimate is based on current financial conditions. Should actual results differ materially from our assumptions, the potential payments will differ from the above estimate.
We routinely enter into contracts that include embedded indemnifications that have characteristics similar to guarantees. Guarantees and indemnifications of the Company and its subsidiaries include obligations to protect counterparties from losses arising from the following: (1) tax, legal and other risks related to the purchase or disposition of businesses; (2) penalties and interest assessed by federal and state taxing authorities in connection with tax returns prepared for clients; (3) indemnification of our directors and officers; and (4) third-party claims relating to various arrangements in the normal course of business. Typically, there is no stated maximum payment related to these indemnifications, and the terms of the indemnities may vary and in many cases are limited only by the applicable statute of limitations. The likelihood of any claims being asserted against us and the ultimate liability related to any such claims, if any, is difficult to predict. While we cannot provide assurance we will ultimately prevail in the event any such claims are asserted, we believe the fair value of guarantees and indemnifications relating to our continuing operations is not material as of January 31, 2012.
We evaluated our financial interests in variable interest entities (VIEs) as of January 31, 2012 and determined that, other than the changes related to the sale of RSM, there have been no significant changes related to those financial interests.
Discontinued Operations Representation and Warranty Obligations
SCC ceased originating mortgage loans in December 2007 and, in April 2008, sold its servicing assets and discontinued its remaining operations. The sale of servicing assets did not include the sale of any mortgage loans.
In connection with the sale of loans and/or residential mortgage-backed securities (RMBS), SCC made certain representations and warranties, including, but not limited to, representations relating to matters such as ownership of the loan, validity of the lien securing the loan, borrower fraud and the loans compliance with SCCs underwriting criteria. Representations and warranties related to borrower fraud in whole loan sale transactions to institutional investors, which represented approximately 68% of the disposal of originated loans, included a knowledge qualifier which limits SCCs 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 did not include a knowledge qualifier. In the event that there is a breach of a representation and warranty and such breach materially and adversely affects the value of a mortgage loan or a securitization insurers or bondholders interest in the mortgage loan, SCC may be obligated to repurchase the loan or otherwise indemnify certain parties for losses incurred in connection with loan liquidation. Generally, repurchase requests are not subject to a stated term, but actions to enforce a repurchase obligation would be subject to the applicable statutes of limitations.
Representation and warranty claims received by SCC have primarily related to alleged breaches of representations and warranties related to a loans compliance with the underwriting standards established by SCC at origination and borrower fraud. Claims received since May 1, 2008 are as follows:
SCC received $35 million in claims in the third quarter of fiscal year 2012, most of which were asserted by a private-label securitization trustee on behalf of bondholders ($29 million) with the remainder asserted by monoline insurers ($6 million). The nature of the claims and the characteristics of the loans to which they relate, including loan vintage, loan performance characteristics, and alleged breaches of representations and warranties, are generally consistent with claims received in prior periods. The amount of claims received varies from period to period, and these variances have been and are expected to continue to fluctuate substantially. Although there is no certainty regarding future claims volume, expiring statutes of limitations and developments in securities litigation and other proceedings to which we are not a party could impact claim volumes during upcoming periods. SCC believes that claim volumes fluctuate in relation to the volume of requests from third parties for access to loan files managed by the party that services the majority of the outstanding SCC-originated loans. SCC and the servicer are currently in a legal dispute over the manner in which the servicer provides that access and the results of the dispute could impact the loan file access of third parties.
For claims received, reviewed and determined to be valid or otherwise settled, SCC has complied with its obligations by either repurchasing the mortgage loans or related collateral, reimbursing losses in connection with liquidated collateral, or reaching other settlements. Since May 2008, SCC has denied approximately 88% of all claims reviewed, excluding loans covered by other settlements. Of claims determined to be valid, approximately 22% resulted in loan repurchases and 78% resulted in reimbursement or settlement payments. Losses on loan repurchase, indemnification and settlement payments totaled approximately $120 million for the period May 1, 2008 through January 31, 2012. Loss severity rates on repurchases and indemnification have approximated 59% and SCC has not observed any material trends related to average losses. Repurchased loans are considered held for sale and are included in prepaid expenses and other current assets on the condensed consolidated balance sheets. The net balance of all mortgage loans held for sale by SCC was $10.6 million at January 31, 2012.
SCC generally has 60 to 120 days to respond to representation and warranty claims and performs a loan-by-loan review of all claims during this time. During the current quarter, SCC completed its review of prior period claims with an approximate principal balance of $220 million. Claims determined to be valid during the current quarter have estimated losses of $1.2 million. Payments related to these claims remained pending at January 31, 2012. Counterparties are able to reassert claims that SCC has denied. Claims totaling approximately $399 million remained subject to review as of January 31, 2012. As of January 31, 2012, approximately $79 million of claims under review represent a reassertion of previously denied claims.
All claims asserted against SCC since May 1, 2008 relate to loans originated during calendar years 2005 through 2007, of which, approximately 90% relate to loans originated in calendar years 2006 and 2007. During calendar years 2005 through 2007, SCC originated approximately $84 billion in loans, of which less than 1% were sold directly to government sponsored entities. Government sponsored entities also purchased bonds backed by SCC-originated mortgage loans and, with respect to these bonds, have the same rights as other bondholders in private label securitizations. SCC is not subject to representation and warranty losses on loans that have been paid in full, repurchased, or were sold without recourse.
The majority of claims asserted since May 1, 2008 determined by SCC to represent a valid breach of its representations and warranties, relate to loans that became delinquent within the first two years following the origination of the mortgage loan. Based on its experiences to date, SCC believes the longer a loan performs prior to an event of default, the less likely the default will be related to a breach of a representation and warranty. A loan that defaults within the first two years following the origination of the mortgage loan does not necessarily default due to a breach of a representation and warranty. Loans originated in 2005, 2006 and 2007 that defaulted in the first two years totaled $4.0 billion, $6.3 billion and $2.9 billion, respectively.
SCC estimates losses relating to representation and warranty claims by estimating loan repurchase and indemnification obligations based on historical validity and severity rates on both known claims and projections of future claims. Projections of future claims are based on an analysis that includes a review of the terms and provisions of related agreements, the historical experience under repurchase and indemnification obligations related to breaches of representations and warranties and third-party activity, which includes inquiries from various third-parties, loan file access by third parties, and repurchase
demands. SCCs methodology for calculating this liability also includes an assessment of the probability that individual counterparties (private label securitization trustees on behalf of bondholders, monoline insurers and whole-loan purchasers) will assert future claims.
SCC has recorded a liability for estimated contingent losses related to representation and warranty claims as of January 31, 2012 of $142.9 million, which represents SCCs estimate of the probable loss that may occur. Although SCC reviewed claims during the quarter that were deemed valid, payments related to those claims were still pending as of January 31, 2012. As such, the balance of the recorded liability at January 31, 2012 remained unchanged from the preceding quarter. During the second quarter of fiscal year 2012, SCC observed substantially increased third-party activity. As a result of this third-party activity, SCCs estimate of probable claims increased from its prior expectations and accordingly, it recorded an additional loss provision at the end of the second quarter. In the third quarter of fiscal year 2012, third-party activity decreased relative to the second quarter. During the prior fiscal year, SCC made payments totaling $49.8 million under an indemnity agreement dated April 2008 with a specific counterparty in exchange for a full and complete release of such partys ability to assert representation and warranty claims. The indemnity agreement was given as part of obtaining the counterpartys consent to SCCs sale of its mortgage servicing business in 2008. SCC has no remaining payment obligations under this indemnity agreement.
The recorded liability represents SCCs estimate of losses from future representation and warranty claims where assertion of a claim and a related contingent loss are both determined to be probable. Because the rate at which future claims may be determined to be valid and actual loss severity rates may differ significantly from historical experience, SCC is not able to estimate reasonably possible loss outcomes in excess of its current accrual. A 1% increase in both assumed validity rates and loss severities would result in losses beyond SCCs accrual of approximately $22 million. This sensitivity is hypothetical and is intended to provide an indication of the impact of a change in key assumptions on the representations and warranties liability. In reality, changes in one assumption may result in changes in other assumptions, which could affect the sensitivity and the amount of losses.
While SCC uses what it believes to be the best information available to it in estimating its liability, assessing the likelihood that claims will be asserted in the future and estimating probable losses are inherently subjective and require considerable management judgment. To the extent that the volume of asserted claims, the level of valid claims, the counterparties asserting claims, the nature of claims, or the value of residential home prices, among other factors, differ in the future from current estimates, future losses may be greater than the current estimates and those differences may be significant.
A rollforward of our liability for losses on repurchases for the nine months ended January 31, 2012 and 2011 is as follows:
Discontinued Operations Indemnification Obligations
SCC may also have indemnification obligations with respect to loans and securities it originated and sold, as discussed in note 14.
See discussion in note 13 below for indemnification obligations related to the sales of RSM and MCM.
As of January 31, 2012, the results of operations and the related losses on the sale of RSM and MCM businesses are presented as discontinued operations in the condensed consolidated financial statements. Our discontinued operations also include the results of operations of SCC, which exited its mortgage business in fiscal year 2008.
In connection with the sale of RSM and MCM, we indemnified the buyers against certain litigation matters. The indemnities are not subject to a stated term or limit. Accounting Standards Codification 460 Guarantees (ASC 460) requires that we recognize a liability for the estimated fair value of guarantee and indemnification obligations at the inception of the arrangement. We have estimated an aggregate fair value of $6.0 million related to these indemnifications and recorded a liability in that amount as of the date of the sales. Subsequent changes in this liability will be determined in accordance with ASC 460 and ASC 450 Loss Contingencies and recorded in discontinued operations.
The results of operations of our discontinued operations are as follows:
The sale of RSM resulted in a pretax financial statement loss, but produced a gain for tax purposes. The tax gain resulted primarily from larger amortization deductions taken for tax purposes than for financial statement purposes. A portion of the gain from the sale of intangible assets is capital in nature and can be offset by utilization of capital loss carry forwards. A net income tax benefit of $20.5 million was recorded in discontinued operations related to the sale.
We are a defendant in a large number of litigation matters, arising both in the ordinary course of business and otherwise, including as described below. The matters described below are not all of the lawsuits to which we are subject. In some of the matters, very large and/or indeterminate amounts, including punitive damages, are sought. U.S. jurisdictions permit considerable variation in the assertion of monetary damages or other relief. Jurisdictions may permit claimants not to specify the monetary damages sought or may permit claimants to state only that the amount sought is sufficient to invoke the jurisdiction of the trial court. In addition, jurisdictions may permit plaintiffs to allege monetary damages in amounts well exceeding reasonably possible verdicts in the jurisdiction for similar matters. We believe that the monetary relief which may be specified in a lawsuit or claim bears little relevance to its merits or disposition value due to this variability in pleadings and our experience in litigating or resolving through settlement numerous claims over an extended period of time.
The outcome of a litigation matter and the amount or range of potential loss at particular points in time may be difficult to ascertain. Among other things, uncertainties can include how fact finders will evaluate documentary evidence and the credibility and effectiveness of witness testimony, and how trial and appellate courts will apply the law. Disposition valuations are also subject to the uncertainty of how opposing parties and their counsel will themselves view the relevant evidence and applicable law.
In addition to litigation matters, we are also subject to other claims and regulatory investigations arising out of our business activities, including as described below.
We establish liabilities for litigation and regulatory loss contingencies when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Liabilities have been established for a number of the matters noted below. For such matters where a loss is believed to be reasonably possible, but not probable, no accrual has been made. It is possible that litigation and regulatory matters could require us to pay damages or make other expenditures or establish accruals in amounts that could not be reasonably estimated at January 31, 2012. While the potential future charges could be material in the particular quarterly or annual periods in which they are recorded, based on information currently known, we do not believe any such charges are likely to have a material adverse effect on our consolidated financial position, results of operations and cash flows. As of January 31, 2012, we have accrued $89.0 million, including obligations under certain indemnifications, compared to $70.6 million at April 30, 2011.
Matters as to Which an Estimate Can Be Made
For some matters, we are able to estimate a reasonably possible range of loss. For those matters, as of January 31, 2012, we estimate the aggregate range of reasonably possible losses in excess of amounts accrued to be approximately $0 to $61 million.
Matters as to Which an Estimate Cannot Be Made
For other matters, we are not currently able to estimate the reasonably possible loss or range of loss. We are often unable to estimate the possible loss or range of loss until developments in such matters have provided sufficient information to support an assessment of the range of possible loss, such as quantification of a damage demand from plaintiffs, discovery from other parties and investigation of factual allegations, rulings by the court on motions or appeals, analysis by experts, and the progress of settlement negotiations. On a quarterly and annual basis, we review relevant information with respect to litigation contingencies and update our accruals, disclosures and estimates of reasonably possible losses or ranges of loss based on such reviews.
Litigation and Other Claims Pertaining to Discontinued Mortgage Operations
Although SCCs mortgage loan origination activities ceased in December 2007 and SCCs loan servicing business was sold in April 2008, SCC and HRB have been, remain and may in the future be subject to investigations, claims and lawsuits pertaining to SCCs mortgage business activities that occurred prior to such termination and sale. These investigations, claims and lawsuits include actions by state and federal regulators, third party indemnitees, individual plaintiffs, and cases in which plaintiffs seek to represent a class of others alleged to be similarly situated. Among other things, these investigations, claims and lawsuits allege discriminatory or unfair and deceptive loan origination and servicing practices, fraud and other common law torts, rights to indemnification, and violations of securities laws, the Truth in Lending Act (TILA), Equal Credit Opportunity Act and the Fair Housing Act. Given the non-prime mortgage environment, the number of these investigations, claims and lawsuits has increased over time and is expected to continue to increase further. The amounts claimed in these investigations, claims and lawsuits are substantial in some instances, and the ultimate resulting liability is difficult to predict and thus in many cases cannot be reasonably estimated. In the event of unfavorable outcomes, the amounts that may be required to be paid in the discharge of liabilities or settlements could be substantial and could have a material impact on our consolidated financial position, results of operations and cash flows. Certain of these matters are described in more detail below.
On February 1, 2008, a class action lawsuit was filed in the United States District Court for the District of Massachusetts against SCC and other related entities styled Cecil Barrett, et al. v. Option One Mortgage Corp., et al. (Civil Action No. 08-10157-RWZ). Plaintiffs allege discriminatory practices relating to the origination of mortgage loans in violation of the Fair Housing Act and Equal Credit Opportunity Act,
and seek declaratory and injunctive relief in addition to actual and punitive damages. The court dismissed H&R Block, Inc. from the lawsuit for lack of personal jurisdiction. In March 2011, the court issued an order certifying a class, which defendants sought to appeal. On August 24, 2011, the First Circuit Court of Appeals declined to hear the appeal, noting that the district court could reconsider its certification decision in light of a recent ruling by the United States Supreme Court in an unrelated matter. SCC has filed a motion to decertify the class, which remains pending. A portion of our loss contingency accrual is related to this lawsuit for the amount of loss that we consider probable and estimable. We believe SCC has meritorious defenses to the claims in this case and it intends to defend the case vigorously, but there can be no assurances as to its outcome or its impact on our consolidated financial position, results of operations and cash flows.
On December 9, 2009, a putative class action lawsuit was filed in the United States District Court for the Central District of California against SCC and H&R Block, Inc. styled Jeanne Drake, et al. v. Option One Mortgage Corp., et al. (Case No. SACV09-1450 CJC). Plaintiffs allege breach of contract, promissory fraud, intentional interference with contractual relations, wrongful withholding of wages and unfair business practices in connection with the failure to pay severance benefits to employees when their employment transitioned to American Home Mortgage Servicing, Inc. in connection with the sale of certain assets and operations of Option One. Plaintiffs seek to recover severance benefits of approximately $8 million, interest and attorneys fees, in addition to penalties and punitive damages on certain claims. On September 2, 2011, the court granted summary judgment in favor of the defendants on all claims. Plaintiffs have filed an appeal, which remains pending. We have not concluded that a loss related to this matter is probable nor have we established a loss contingency related to this matter. We believe we have meritorious defenses to the claims in this case and intend to defend the case vigorously, but there can be no assurances as to its outcome or its impact on our consolidated financial position, results of operations and cash flows.
On October 15, 2010, the Federal Home Loan Bank of Chicago filed a lawsuit in the Circuit Court of Cook County, Illinois (Case No. 10CH45033) styled Federal Home Loan Bank of Chicago v. Bank of America Funding Corporation, et al. against multiple defendants, including various SCC-related entities, H&R Block, Inc. and other entities, arising out of FHLBs purchase of mortgage-backed securities. The plaintiff seeks rescission and damages under state securities law and for common law negligent misrepresentation in connection with its purchase of two securities originated and securitized by SCC. These two securities had a total initial principal amount of approximately $50 million, of which approximately $41 million remains outstanding. The plaintiff agreed to voluntarily dismiss H&R Block, Inc. from the suit. The remaining defendants, including SCC, have filed motions to dismiss, which are pending. We have not concluded that a loss related to this matter is probable nor have we established a loss contingency related to this matter. We believe SCC has meritorious defenses to the claims in this case and intends to defend the case vigorously, but there can be no assurances as to its outcome or its impact on our consolidated financial position, results of operations and cash flows.
SCC has been working with the staff of the U.S. Securities and Exchange Commission in connection with the staffs investigation of matters related to eighteen RMBS transactions of SCC. Based on the progress of the investigation, the scope of which has continued to narrow in focus, SCC has offered to resolve the matter with the payment of approximately $28 million. As a result, SCC has established a liability as of January 31, 2012, which is included in our loss contingency accrual. Although we believe that this matter can be resolved on satisfactory terms, any resolution of this matter would require approval by the U.S. Securities and Exchange Commission and of the U.S District Court, neither of which has been obtained, and which we cannot provide assurance will be obtained on satisfactory terms or at all.
SCC or its subsidiaries entered into indemnification agreements with certain third parties that sold or underwrote the sale of securities. Some of those third parties are defendants in lawsuits where various other parties are seeking damages and other remedies based on the activities of such third parties in the sale of RMBS, including in some instances, SCC securitizations. SCC has received notices from some of these third parties for indemnification against losses, including defense costs, that those third parties might incur as a result of these lawsuits. We have not concluded that a loss related to any of these matters is probable nor have we established a loss contingency related to any of these matters.
Employment-Related Claims and Litigation
We have been named in several wage and hour class action lawsuits throughout the country, including Alice Williams v. H&R Block Enterprises LLC, Case No. RG08366506 (Superior Court of California, County of Alameda, filed January 17, 2008) (alleging improper classification and failure to compensate for all hours worked and to provide meal periods to office managers in California); Arabella Lemus, et al. v. H&R Block Enterprises LLC, et al., Case No. CGC-09-489251 (United States District Court, Northern District of California, filed June 9, 2009) (alleging failure to timely pay compensation to tax professionals in California); Delana Ugas, et al. v. H&R Block Enterprises LLC, et al., Case No. BC417700 (United States District Court, Central District of California, filed July 13, 2009) (alleging failure to compensate tax professionals in California for all hours worked and to provide meal periods); and Barbara Petroski, et al. v. H&R Block Eastern Enterprises, Inc., et al., Case No. 10-CV-00075 (United States District Court, Western District of Missouri, filed January 25, 2010) (alleging failure to compensate tax professionals nationwide for off-season training).
A class was certified in the Lemus case in December 2010 (consisting of tax professionals who worked in company-owned offices in California from 2007 to 2010); in the Williams case in March 2011 (consisting of office managers who worked in company-owned offices in California from 2004 to 2011); and in the Ugas case in August 2011 (consisting of tax professionals who worked in company-owned offices in California from 2006 to 2011). In Petroski, a conditional class was certified under the Fair Labor Standards Act in March 2011 (consisting of tax professionals nationwide who worked in company-owned offices and who were not compensated for certain training courses occurring on or after April 15, 2007). Two classes were also certified under state laws in California and New York (consisting of tax professionals who worked in company-owned offices in those states). A trial date has been set in the Williams case for April 30, 2012.
The plaintiffs in the wage and hour class action lawsuits seek actual damages, pre-judgment interest and attorneys fees, in addition to statutory penalties under state and federal law, which could equal up to 30 days of wages per tax season for class members who worked in California. A portion of our loss contingency accrual is related to these lawsuits for the amount of loss that we consider probable and estimable. The amounts claimed in these matters are substantial in some instances and the ultimate liability with respect to these matters is difficult to predict. We believe we have meritorious defenses to the claims in these cases and intend to defend the cases vigorously, but there can be no assurances as to the outcome of these cases or their impact on our consolidated financial position, results of operations and cash flows, individually or in the aggregate.
To avoid the cost and inherent risk associated with litigation, we reached an agreement to settle the Lemus case in January 2012, subject to approval by the federal court in California in which the case is pending. This settlement would require a maximum payment of $35 million, although the actual cost of the settlement would depend on the number of valid claims submitted by class members. The federal court granted preliminary approval of the settlement on February 10, 2012. A final approval hearing is scheduled to occur on May 10, 2012. We have recorded a liability for our estimate of the expected loss. If for any reason the settlement is not approved, we will continue to defend the case vigorously, but there can be no assurances as to its outcome or its impact on our consolidated financial position, results of operations and cash flows.
RAL and RAC Litigation
We have been named in a putative class action styled Sandra J. Basile, et al. v. H&R Block, Inc., et al., April Term 1992 Civil Action No. 3246 in the Court of Common Pleas, First Judicial District Court of Pennsylvania, Philadelphia County, instituted on April 23, 1993. The plaintiffs allege inadequate disclosures with respect to the RAL product and assert claims for violation of consumer protection statutes, negligent misrepresentation, breach of fiduciary duty, common law fraud, usury, and violation of the TILA. Plaintiffs seek unspecified actual and punitive damages, injunctive relief, attorneys fees and costs. A Pennsylvania class was certified, but later decertified by the trial court in December 2003. An appellate court subsequently reversed the decertification decision. We are appealing the reversal. We have not concluded that a loss related to this matter is probable nor have we accrued a loss contingency related to this matter. We believe we have meritorious defenses to this case and intend to defend the case
vigorously, but there can be no assurances as to the outcome of this case or its impact on our consolidated financial position, results of operations and cash flows.
A series of class action lawsuits were filed against us in various federal courts beginning on November 17, 2011 concerning the RAL and RAC products, styled Anthony Johnson v. H&R Block, Inc., et. al. (Case No. 2:11-cv-09577) (C.D. Cal.); Norma Molina-Servin v. H&R Block, Inc., et. al. (Case No. 1:11-cv-08244) (N.D. Ill.); William Wimbley v. H&R Block, Inc., et. al. (Case No. 1:11-cv-24159) (S.D. Fla.); Sandy Morton v. H&R Block, Inc., et. al. (Case No. 4:11-cv-00859) (E.D. Ark.); Iris Orta v. H&R Block, Inc., et. al. (Case No. 2:11-cv-01149) (E.D. Wis.); Maggie Murchio v. H&R Block, Inc., et. al. (Case No.1:12-cv-00063) (W.D. Md.); and Catherine Gaddy v. H&R Block, Inc., et. al. (Case No. 1:12-cv-00052) (M.D. N.C). The plaintiffs generally allege we engaged in unfair, deceptive and/or fraudulent acts in violation of various state consumer protection laws by facilitating RALs that were accompanied by allegedly inaccurate TILA disclosures, and by offering RACs without any TILA disclosures. Certain plaintiffs also allege violation of disclosure requirements of various state statutes expressly governing RALs and provisions of those statutes prohibiting tax preparers from charging or retaining certain fees. Collectively, the plaintiffs seek to represent clients who purchased RAL or RAC products in up to forty-two states and the District of Columbia during timeframes ranging from 2007 to the present. The plaintiffs seek equitable relief, disgorgement of profits, compensatory and statutory damages, restitution, civil penalties, attorneys fees and costs. The plaintiffs filed a motion with the Judicial Panel on Multidistrict Litigation on December 9, 2011 to consolidate the cases before a single court for pretrial proceedings (In Re Refund Anticipation Loan Litigation, MDL No. 2334). This motion remains pending. We have not concluded that a loss related to this matter is probable nor have we accrued a loss contingency related to this matter. We believe we have meritorious defenses to the claims in these cases, and we intend to defend the cases vigorously, but there can be no assurances as to the outcome or the impact on our consolidated financial position, results of operations and cash flows.
Express IRA Litigation
We have one remaining lawsuit regarding our former Express IRA product. That case was filed on January 2, 2008 by the Mississippi Attorney General in the Chancery Court of Hinds County, Mississippi First Judicial District (Case No. G 2008 6 S 2) and is styled Jim Hood, Attorney for the State of Mississippi v. H&R Block, Inc., H&R Block Financial Advisors, Inc., et al. The complaint alleges fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the sale of the product in Mississippi and seeks equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. We believe we have meritorious defenses to the claims in this case and intend to defend the case vigorously, but there can be no assurances as to its outcome or its impact on our consolidated financial position, results of operations and cash flows.
Although we sold H&R Block Financial Advisors, Inc. (HRBFA) effective November 1, 2008, we remain responsible for any liabilities relating to the Express IRA litigation, among other things, through an indemnification agreement. A portion of our accrual is related to these indemnity obligations.
Litigation and Claims Pertaining to the Discontinued Operations of RSM McGladrey
On April 17, 2009, a shareholder derivative complaint was filed by Brian Menezes, derivatively and on behalf of nominal defendant International Textile Group, Inc. against McGladrey Capital Markets, LLC (MCM) in the Court of Common Pleas, Greenville County, South Carolina (C.A. No. 2009-CP-23-3346) styled Brian P. Menezes, Derivatively on Behalf of Nominal Defendant, International Textile Group, Inc. (f/k/a Safety Components International, Inc.) v. McGladrey Capital Markets, LLC (f/k/a RSM EquiCo Capital Markets, LLC), et al. Plaintiffs filed an amended complaint in October 2011 styled In re International Textile Group Merger Litigation, adding a putative class action claim against MCM. Plaintiffs allege claims of aiding and abetting, civil conspiracy, gross negligence and breach of fiduciary duty against MCM in connection with a fairness opinion MCM provided to the Special Committee of Safety Components International, Inc. (SCI) in 2006 regarding the merger between International Textile Group, Inc. and SCI. Plaintiffs seek actual and punitive damages, pre-judgment interest, attorneys fees and costs. On February 8, 2012, the court dismissed plaintiffs civil conspiracy claim against all defendants. Plaintiffs
other claims remain pending. We have not concluded that a loss related to this matter is probable nor have we established a loss contingency related to this matter. We believe we have meritorious defenses to the claims in this case and intend to defend the case vigorously, but there can be no assurances as to its outcome or its impact on our consolidated financial position, results of operations and cash flows.
EquiCo, its parent and certain of its subsidiaries and affiliates, are parties to a class action filed on July 11, 2006 and styled Do Rights Plant Growers, et al. v. RSM EquiCo, Inc., et al. (the RSM Parties), Case No. 06 CC00137, in the California Superior Court, Orange County. The complaint contains allegations relating to business valuation services provided by EquiCo, including allegations of fraud, conversion and unfair competition. Plaintiffs seek unspecified actual and punitive damages, in addition to pre-judgment interest and attorneys fees. On March 17, 2009, the court granted plaintiffs motion for class certification on all claims. To avoid the cost and inherent risk associated with litigation, the parties reached an agreement to settle the case for a maximum payment of $41.5 million, although the actual cost of the settlement will depend on the number of valid claims submitted by class members. The California Superior Court granted final approval of the settlement on October 20, 2011. We previously recorded a liability for our best estimate of the expected loss. The amount we paid during our third quarter did not exceed the amount we had previously accrued.
We are from time to time party to investigations, claims and lawsuits not discussed herein arising out of our business operations. These investigations, claims and lawsuits may include actions by state attorneys general, other state regulators, federal regulators, individual plaintiffs, and cases in which plaintiffs seek to represent a class of others similarly situated. We believe we have meritorious defenses to each of these investigations, claims and lawsuits, and we are defending or intend to defend them vigorously. The amounts claimed in these matters are substantial in some instances; however, the ultimate liability with respect to such matters is difficult to predict. In the event of an unfavorable outcome, the amounts we may be required to pay in the discharge of liabilities or settlements could have a material impact on our consolidated financial position, results of operations and cash flows.
We are also party to claims and lawsuits that we consider to be ordinary, routine litigation incidental to our business, including claims and lawsuits (collectively, Other Claims) concerning the preparation of customers income tax returns, the fees charged customers for various products and services, relationships with franchisees, intellectual property disputes, employment matters and contract disputes. While we cannot provide assurance that we will ultimately prevail in each instance, we believe the amount, if any, we are required to pay in the discharge of liabilities or settlements in these Other Claims will not have a material impact on our consolidated financial position, results of operations and cash flows.
Results of our continuing operations by reportable operating segment are as follows:
As of January 31, 2012, the results of operations of our previously reported Business Services segment are presented as discontinued operations in the condensed consolidated statements of operations. All periods presented have been reclassified to reflect our discontinued operations. See notes 1 and 13 for additional information.
In September 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2011-08, Intangibles Goodwill and Other (Topic 350): Testing Goodwill for Impairment. Under the amendments in this guidance, an entity may consider qualitative factors before applying Step 1 of the goodwill impairment assessment, but may no longer be permitted to carry forward estimates of a reporting units fair value from a prior year when specific criteria are met. These amendments are effective for goodwill impairment tests performed in fiscal years beginning after December 15, 2011. Early adoption is permitted. We are currently evaluating the effect of this guidance on our condensed consolidated financial statements.
In June 2011, the FASB issued Accounting Standards Update 2011-05, Comprehensive Income (Topic 220): Statement of Comprehensive Income. Under the amendments in this guidance, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders equity. The amendments in this guidance do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. These amendments are effective for fiscal years beginning after December 15, 2011. Early adoption is permitted. We elected to adopt this guidance as of May 1, 2011, and it did not have an effect on our presentation of comprehensive income in our condensed consolidated financial statements.
In May 2011, the FASB issued Accounting Standards Update 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. Under the amendments in this guidance, an entity will be required to provide additional disclosures about the valuation processes and sensitivities of Level 3 assets and the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position, but for which the fair value is required to be disclosed These amendments are effective for interim and annual periods beginning after December 15, 2011. Early adoption is not permitted. We do not expect this guidance to have a material effect on our condensed consolidated financial statements.
In April 2011, the FASB issued Accounting Standards Update 2011-02, Receivables (Topic 310) A Creditors Determination of Whether a Restructuring is a Troubled Debt Restructuring. This guidance assists in determining if a loan modification qualifies as a TDR and requires that creditors must determine that a concession has been made and the borrower is having financial difficulties. We adopted this guidance as of May 1, 2011. We did not identify any new TDRs attributable to this new guidance and it did not have a material effect on our condensed consolidated financial statements.
In October 2009, the FASB issued Accounting Standards Update 2009-13, Revenue Recognition (Topic 605) Multiple-Deliverable Revenue Arrangements. This guidance amends the criteria for separating consideration in multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. This guidance establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (1) vendor-specific objective evidence; (2) third-party evidence; or (3) estimates. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. In addition, this guidance significantly expands required disclosures related to a vendors new multiple-deliverable revenue arrangements. We adopted this guidance as of May 1, 2011 and it did not have a material effect on our condensed consolidated financial statements.
In December 2010, the FASB issued Accounting Standards Update 2010-28, Intangibles Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The amendments affect reporting units whose carrying amount is
zero or negative, and require performance of Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, a reporting unit would consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with existing guidance. The reporting unit would evaluate if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. We adopted this guidance as of May 1, 2011 and it did not have a material effect on our condensed consolidated financial statements.
In December 2010, the FASB issued Accounting Standards Update 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. The amendments in this guidance specify that if a public entity presents comparative financial statements, the entity would disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. Additionally, disclosures should be accompanied by a narrative description about the nature and amount of material, nonrecurring pro forma adjustments. We adopted this guidance as of May 1, 2011 and it did not have a material effect on our condensed consolidated financial statements.
BFC is an indirect, wholly-owned subsidiary of the Company. BFC is the Issuer and the Company is the Guarantor of the Senior Notes issued on January 11, 2008 and October 26, 2004, our CLOC and other indebtedness issued from time to time. These condensed consolidating financial statements have been prepared using the equity method of accounting. Earnings of subsidiaries are, therefore, reflected in the Companys investment in subsidiaries account. The elimination entries eliminate investments in subsidiaries, related stockholders equity and other intercompany balances and transactions.