H&R Block Shares Rise on Beat

Shares of H&R Block(HRB Quote - Cramer on HRB - Stock Picks) surged as much as 7% early Thursday, after the tax preparation giant trimmed its losses in its fiscal third quarter as it attempted to bounce back from its foray into the mortgage business.

Excluding one-time items, the company reported earnings of $25 million, or 8 cents a share, for the quarter ended Jan. 31, vs. $21.9 million, or 7 cents a share, in the year-ago period. Including a pretax charge of $26.3 million for expenses in connection with corporate staff reductions and executive severance, H&R Block's adjusted net income was actually $9.3 million, or 3 cents per share. The charge was really $15.7 million after a tax benefit or 5 cents a share.

Analysts polled by Thomson Financial, which usually exclude one-time items, had expected a profit of 6 cents a share on revenue of $1 billion. The stock was recently trading up $5% to $18.10.

Net losses from its discontinued operations, which include its subprime mortgage lender Option One Mortgage, were $56.6 million, smaller than the $82.2 million those operations lost a year earlier. An agreement to sell the operation to private-equity firm Cerberus Capital collapsed in December.

On a positive note, revenues rose 4.4% to $972.6 million and retail clients served increased 2.6%. But customers are not flocking to the digital tax business, which showed a decline in the number of clients for the quarter of 10.8% and digital revenues were down 1.9% and the company experienced 3.5% drop in the number of clients coming to its retail tax offices during the quarter. However, overall tax revenue is up 5.4% from a year ago due to a fee increase.

"We are only halfway through tax season, but we believe we have good marketplace traction and excellent opportunities based on our market share, the quality of our tax professionals and the strength of our brand," Chairman Richard Breeden said in a company statement.

Breeden, an activist investor and former Securities and Exchange Commission chairman, took over the chairman role and three board seats in September. He had argued that H&R Block should quit banking and subprime mortgage lending and focus on tax preparation.

The credit crisis affecting so many companies did not spare H&R Block. According to its 10K, the company has not been able to issue commercial paper due to the market conditions and has been borrowing under its unsecured revolving committed lines of credit, or CLOCs. The company has used $1.8 billion of a total borrowing capacity of $2.0 billion. "A further disruption in credit markets, or a violation of covenants under our CLOCs, could adversely affect our access to these funds," the company said. "To meet our future financing needs we may issue additional debt or equity securities."

Goldman Sachs analyst James Fotheringham wrote on Feb. 21 that "our enthusiasm is tempered by capital concerns. Block remains below the 3% tangible-equity-to-tangible-assets OTS target ratio, which may necessitate a capital raise." He also reinstated his rating as "neutral" at that point with a 12-month target price of $20.

Tax rival Jackson Hewitt(JTX Quote - Cramer on JTX - Stock Picks) has also experienced a slow start to the tax season and the stock has dropped 56% in value over the last year. Jackson Hewitt was trading down 9.4% to $12.68 Thursday.