SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, 2007

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 1-6089

H&R Block, Inc.

MISSOURI		44-0607856
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

One H&R Block Way
Kansas City, Missouri 64105
(Address of principal executive offices, including zip code)

(816) 854-3000
(Registrant’s 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 þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)

Large accelerated filer þ     Accelerated filer o      Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The number of shares outstanding of the registrant’s Common Stock, without par value, at the close of business on August 31, 2007 was 324,632,718 shares.

 

 

Table of Contents

		Page
PART I Financial Information
Item 1. Condensed Consolidated Balance Sheets July 31, 2007 and April 30, 2007			1
Condensed Consolidated Statements of Income and Comprehensive Income Three Months Ended July 31, 2007 and 2006			2
Condensed Consolidated Statements of Cash Flows Three Months Ended July 31, 2007 and 2006			3
Condensed Consolidated Statement of Stockholders’ Equity July 31, 2007 and April 30, 2007			4
Notes to Condensed Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
Item 3. Quantitative and Qualitative Disclosures about Market Risk			49
Item 4. Controls and Procedures			51
PART II Other Information
Item 1. Legal Proceedings			51
Item 1A. Risk Factors			54
Item 2. Unregistered Sales of Equity Securities			56
Item 5. Other Information			56
Item 6. Exhibits			57
SIGNATURES			58
License Agreement
Amendment No.11 to the Amended and Restated Indenture
Amendment No.9 to Amended and Restated Note Purchase Agreement
waiver and Amendment No. 2 to Amended and Restated Sale and Servicing Agreement
302 Certification of Chief Executive Officer
302 Certification of Chief Financial Officer
906 Certification of Chief Executive Officer
906 Certification of Chief Financial Officer

CONDENSED CONSOLIDATED BALANCE SHEETS		(amounts in 000s, except share and per share amounts)

		July 31, 2007				April 30, 2007
		(Unaudited)
ASSETS
Cash and cash equivalents		$	437,671			$	921,838
Cash and cash equivalents — restricted			287,789				332,646
Receivables from customers, brokers, dealers and clearing organizations, less allowance for doubtful accounts of $2,314 and $2,292			404,420				410,522
Receivables, less allowance for doubtful accounts of $95,530 and $99,259			423,450				556,255
Prepaid expenses and other current assets			224,834				208,564
Current assets of discontinued operations, held for sale			1,110,427				1,024,467
Total current assets			2,888,591				3,454,292
Mortgage loans held for investment, less allowance for loan losses of $4,585 and $3,448			1,241,281				1,358,222
Property and equipment, at cost less accumulated depreciation and amortization of $656,335 and $647,151			372,235				379,066
Intangible assets, net			173,799				181,413
Goodwill			1,006,278				993,919
Other assets			484,081				454,646
Noncurrent assets of discontinued operations, held for sale			701,805				722,492
Total assets		$	6,868,070			$	7,544,050
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Commercial paper and other short-term borrowings		$	1,651,237			$	1,567,082
Customer banking deposits			1,039,238				1,129,263
Accounts payable to customers, brokers and dealers			615,858				633,189
Accounts payable, accrued expenses and other current liabilities			398,864				519,372
Accrued salaries, wages and payroll taxes			131,274				307,854
Accrued income taxes			113,739				439,472
Current portion of long-term debt			9,371				9,304
Current liabilities of discontinued operations, held for sale			750,782				615,373
Total current liabilities			4,710,363				5,220,909
Long-term debt			519,803				519,807
Other noncurrent liabilities			556,542				388,835
Total liabilities			5,786,708				6,129,551
Stockholders’ equity:
Common stock, no par, stated value $.01 per share, 800,000,000 shares authorized, 435,890,796 shares issued at July 31, 2007 and April 30, 2007			4,359				4,359
Additional paid-in capital			671,647				676,766
Accumulated other comprehensive income (loss)			2,528				(1,320	)
Retained earnings			2,530,207				2,886,440
Less cost of 111,344,662 and 112,671,610 shares of common stock in treasury			(2,127,379	)			(2,151,746	)
Total stockholders’ equity			1,081,362				1,414,499
Total liabilities and stockholders’ equity		$	6,868,070			$	7,544,050

See Notes to Condensed Consolidated Financial Statements

CONDENSED CONSOLIDATED STATEMENTS OF		(unaudited, amounts in 000s,
INCOME AND COMPREHENSIVE INCOME		except per share amounts)

Three months ended July 31,		2007				2006
Revenues:
Service revenues		$	321,663			$	302,796
Other revenues:
Interest income			41,838				25,710
Product and other revenues			17,708				14,264
			381,209				342,770
Operating expenses:
Cost of services			383,400				363,525
Cost of other revenues			43,529				18,207
Selling, general and administrative			145,824				149,071
			572,753				530,803
Operating loss			(191,544	)			(188,033	)
Interest expense			(595	)			(12,135	)
Other income, net			8,559				6,194
Loss from continuing operations before tax benefit			(183,580	)			(193,974	)
Income tax benefit			(73,757	)			(76,135	)
Net loss from continuing operations			(109,823	)			(117,839	)
Loss from discontinued operations, net of tax			(192,757	)			(13,538	)
Net loss		$	(302,580	)			(131,377	)
Basic and diluted loss per share:
Net loss from continuing operations		$	(0.34	)		$	(0.36	)
Net loss from discontinued operations			(0.59	)			(0.05	)
Net loss		$	(0.93	)		$	(0.41	)
Basic and diluted shares			323,864				323,671
Dividends per share		$	0.14			$	0.13
Comprehensive income (loss):
Net loss		$	(302,580	)		$	(131,377	)
Change in unrealized gain on available-for-sale securities, net			(463	)			(2,511	)
Change in foreign currency translation adjustments			4,311				818
Comprehensive loss		$	(298,732	)		$	(133,070	)

See Notes to Condensed Consolidated Financial Statements

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS		(unaudited, amounts in 000s)

Three months ended July 31,		2007				2006
Cash flows from operating activities:
Net loss		$	(302,580	)		$	(131,377	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			37,075				34,627
Stock-based compensation expense			7,398				8,179
Changes in assets and liabilities of discontinued operations			115,486				175,207
Other, net of business acquisitions			(289,562	)			(562,695	)
Net cash used in operating activities			(432,183	)			(476,059	)
Cash flows from investing activities:
Mortgage loans originated or purchased for investment, net			111,164				(135,161	)
Purchases of property and equipment, net			(14,497	)			(34,358	)
Payments made for business acquisitions, net of cash acquired			(20,887	)			(4,627	)
Net cash provided by (used in) investing activities of discontinued operations			3,068				(3,871	)
Other, net			6,699				1,774
Net cash provided by (used in) investing activities			85,547				(176,243	)
Cash flows from financing activities:
Repayments of commercial paper			(3,463,719	)			(1,034,210	)
Proceeds from issuance of commercial paper			3,622,874				1,223,566
Repayments of lines of credit borrowings			(560,000	)			—
Proceeds from lines of credit borrowings			485,000				—
Customer deposits, net			(90,378	)			404,030
Dividends paid			(43,937	)			(40,485	)
Purchase of treasury shares			—				(180,897	)
Proceeds from exercise of stock options			9,788				6,791
Net cash used in financing activities of discontinued operations			(47,535	)			(100	)
Other, net			(49,624	)			(53,549	)
Net cash provided by (used in) financing activities			(137,531	)			325,146
Net decrease in cash and cash equivalents			(484,167	)			(327,156	)
Cash and cash equivalents at beginning of the period			921,838				673,827
Cash and cash equivalents at end of the period		$	437,671			$	346,671
Supplementary cash flow data:
Income taxes paid		$	9,653			$	190,378
Interest paid on borrowings			27,833				15,504
Interest paid on deposits			15,792				3,198

See Notes to Condensed Consolidated Financial Statements

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY		(unaudited amounts in 000s, except per share amounts)

																						Accumulated
										Convertible								Additional				Other
		Common Stock								Preferred Stock								Paid-in				Comprehensive				Retained				Treasury Stock								Total
		Shares				Amount				Shares				Amount				Capital				Income (Loss)				Earnings				Shares				Amount				Equity
Balances at April 30, 2006			435,891			$	4,359				—			$	—			$	653,053			$	21,948			$	3,492,059				(107,378	)		$	(2,023,620	)		$	2,147,799
Net loss			—				—				—				—				—				—				(131,377	)			—				—				(131,377	)
Unrealized translation gain			—				—				—				—				—				818				—				—				—				818
Change in net unrealized gain on available-for-sale securities			—				—				—				—				—				(2,511	)			—				—				—				(2,511	)
Stock-based compensation			—				—				—				—				10,514				—				—				—				—				10,514
Shares issued for:
Option exercises			—				—				—				—				(746	)			—				—				461				8,756				8,010
Nonvested shares			—				—				—				—				(13,997	)			—				—				719				13,687				(310	)
ESPP			—				—				—				—				627				—				—				253				4,823				5,450
Acquisition of treasury shares			—				—				—				—				—				—				—				(8,370	)			(186,339	)			(186,339	)
Cash dividends paid — $0.13 per share			—				—				—				—				—				—				(40,485	)			—				—				(40,485	)
Balances at July 31, 2006			435,891			$	4,359				—			$	—			$	649,451			$	20,255			$	3,320,197				(114,315	)		$	(2,182,693	)		$	1,811,569
Balances at April 30, 2007			435,891			$	4,359				—			$	—			$	676,766			$	(1,320	)		$	2,886,440				(112,672	)		$	(2,151,746	)		$	1,414,499
Remeasurement of uncertain tax positions upon adoption of FIN 48			—				—				—				—				—				—				(9,716	)			—				—				(9,716	)
Net loss			—				—				—				—				—				—				(302,580	)			—				—				(302,580	)
Unrealized translation gain			—				—				—				—				—				4,311				—				—				—				4,311
Change in net unrealized gain on available-for-sale securities			—				—				—				—				—				(463	)			—				—				—				(463	)
Stock-based compensation			—				—				—				—				9,226				—				—				—				—				9,226
Shares issued for:
Option exercises			—				—				—				—				(1,431	)			—				—				668				12,758				11,327
Nonvested shares			—				—				—				—				(13,349	)			—				—				663				12,669				(680	)
ESPP			—				—				—				—				400				—				—				218				4,161				4,561
Acquisitions			—				—				—				—				35				—				—				8				151				186
Acquisition of treasury shares			—				—				—				—				—				—				—				(230	)			(5,372	)			(5,372	)
Cash dividends paid – $0.14 per share			—				—				—				—				—				—				(43,937	)			—				—				(43,937	)
Balances at July 31, 2007			435,891			$	4,359				—			$	—			$	671,647			$	2,528			$	2,530,207				(111,345	)		$	(2,127,379	)		$	1,081,362

See Notes to Condensed Consolidated Financial Statements

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS		(Unaudited)

1.		Basis of Presentation
		The condensed consolidated balance sheet as of July 31, 2007, the condensed consolidated statements of income and comprehensive income for the three months ended July 31, 2007 and 2006, the condensed consolidated statements of cash flows for the three months ended July 31, 2007 and 2006, and the condensed consolidated statement of stockholders’ equity for the three months ended July 31, 2007 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, cash flows and changes in stockholders’ equity at July 31, 2007 and for all periods presented have been made. 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. Actual results could differ from those estimates.

     “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 reclassifications have been made to prior year amounts to conform to the current year presentation. These reclassifications had no effect on our results of operations or stockholders’ equity as previously reported.

     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, 2007 Annual Report to Shareholders on Form 10-K.

     Operating revenues of the Tax Services and Business Services segments 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 Developments

On April 19, 2007, we entered into an agreement to sell Option One Mortgage Corporation (OOMC). In conjunction with this plan, we also announced we would terminate the operations of H&R Block Mortgage Corporation (HRBMC), a wholly-owned subsidiary of OOMC. During fiscal year 2007, we also committed to a plan to sell two smaller lines of business and completed the wind-down of one other line of business, all of which were previously reported in our Business Services segment. One of these businesses was sold during the three months ended July 31, 2007. Additionally, during fiscal year 2007, we completed the wind-down of our tax operations in the United Kingdom, which were previously reported in Tax Services. As of July 31, 2007, we continued to meet the criteria requiring us to present the related financial results of these businesses as discontinued operations and the assets and liabilities of the business being sold as held-for-sale in the condensed consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations.

     The non-prime residential mortgage loan market has been adversely affected by a weakening housing market and increasing rates of delinquencies and defaults. Warehouse lenders have required significant margin calls from non-prime residential mortgage loan originators, including OOMC, due to declining values of non-prime residential mortgage loans and increasing levels of loans held for sale by lenders for longer periods of time due to softening secondary market conditions.

     We have been significantly and negatively impacted by the events and conditions impacting the broader non-prime residential mortgage loan market. The softening secondary market conditions expose us to margin calls to cover declining values in loans held for sale. In addition, warehouse lenders have discretion over the sale of loans in the secondary market, which may result in losses on sales due to forced sales in depressed market conditions. These exposures are also influenced by loans being held for longer periods of time.

     The declining mortgage market conditions continued in August 2007 and were compounded by illiquidity in the secondary market. In early August 2007, OOMC began only underwriting loan originations to the standards established by Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac). These new underwriting guidelines should enhance the overall credit quality of loans offered for sale, but will significantly reduce origination volume. We expect our loan originations will slow to a rate of about $200 million per month beginning in September 2007. Reductions in loan origination volumes and an increasing frequency of selling loans without retaining servicing rights may adversely impact our loan servicing business. OOMC announced reductions in its mortgage lending workforce and retail facilities in August 2007. The cost of these restructuring activities is estimated at $16 million to $20 million, which will be primarily reflected in the consolidated income statement for the quarter ended October 31, 2007. It is possible that OOMC may need to commit to additional restructuring activities. If current market conditions fail to improve, we believe there could be further impairments to our residual interests, beneficial interests in Trusts, and loans held for sale in our second quarter, potentially in the range of $150 to $200 million pretax. The actual amount of the second quarter impairment will ultimately depend primarily on market conditions at the end of the second quarter.

     While we have taken steps to respond to the rapid and substantial decline in the non-prime residential mortgage loan market, there can be no assurances that such steps will be adequate in the event the non-prime residential loan market experiences additional or sustained market declines. If conditions in the mortgage industry continue to decline, our future operating losses from discontinued operations would continue to be negatively impacted.

     We continue to expect to complete the sale of OOMC pursuant to the April 2007 agreement by December 31, 2007. However, we are not currently in compliance with certain closing conditions required by this agreement and do not believe we will be able to regain compliance with such closing conditions or maintain compliance through the anticipated closing date. We are currently in discussions with Cerberus Capital Management to have such conditions either waived or modified. We are also conducting ongoing discussion regarding potentially modifying the agreement, which may include only selling the servicing platform, although we currently believe it is unlikely that the existing agreement will ultimately be changed. Therefore, it is our intention to consummate the transaction under the existing agreement on or before December 31, 2007. If the sale is not consummated, then we would divest the servicing platform and either divest or wind-down the origination business. There are no assurances that the current agreement will be modified or that the transaction will close. Our condensed consolidated financial statements as of July 31, 2007 include an impairment charge which reflects our best estimate of the valuation of OOMC based on the terms of the existing agreement. See additional discussion in note 11. If the agreement is modified, we may incur additional impairment losses, which could be significant, beyond those that are provided in our financial statements. However, we are currently unable to estimate the amount of such additional impairment, if any, until the terms of a modified agreement are determined.

2.		Earnings (Loss) Per Share
		Basic and diluted loss per share is computed using 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 31.3 million shares and 32.9 million shares for the three months ended July 31, 2007 and 2006, respectively, as the effect would be antidilutive due to the net loss from continuing operations during each period.

     The weighted average shares outstanding for the three months ended July 31, 2007 increased to 323.9 million from 323.7 million at July 31, 2006, primarily due the issuance of treasury shares related to our stock-based compensation plans.

     During the three months ended July 31, 2007 and 2006, we issued 1.6 million and 1.4 million shares of common stock, respectively, pursuant to the exercise of stock options, employee stock purchases and awards of nonvested shares, in accordance with our stock-based compensation plans.

     During the three months ended July 31, 2007, we acquired 0.2 million shares of our common stock, which represent shares swapped or surrendered to us in connection with the vesting of nonvested shares and the exercise of stock options, at an aggregate cost of $5.4 million. During the three months ended July 31, 2006, we

acquired 8.4 million shares of our common stock, of which 8.1 million shares were purchased from third parties with the remaining shares swapped or surrendered to us, at an aggregate cost of $186.3 million.

     During the three months ended July 31, 2007, we granted 4.9 million stock options and 0.9 million nonvested shares and units in accordance with our stock-based compensation plans. The weighted average fair value of options granted was $4.54 for manager and director options and $3.07 for seasonal options. At July 31, 2007, the total unrecognized compensation cost for options and nonvested shares and units was $27.5 million and $52.2 million, respectively.

3.		Goodwill and Intangible Assets
		Changes in the carrying amount of goodwill of continuing operations for the three months ended July 31, 2007 consist of the following:

														(in 000s)
		April 30, 2007				Additions				Other				July 31, 2007
Tax Services		$	415,077			$	12,833			$	6,367			$	434,277
Business Services			404,888				925				(7,766	)			398,047
Consumer Financial Services			173,954				—				—				173,954
Total		$	993,919			$	13,758			$	(1,399	)		$	1,006,278

     We test goodwill for impairment annually at the beginning of our fourth quarter, or more frequently if events occur indicating it is more likely than not the fair value of a reporting unit’s net assets has been reduced below its carrying value. No impairments of goodwill were identified within any of our operating segments during the three months ended July 31, 2007.

     Intangible assets of continuing operations consist of the following:

																						(in 000s)
		July 31, 2007												April 30, 2007
		Gross												Gross
		Carrying				Accumulated								Carrying				Accumulated
		Amount				Amortization				Net				Amount				Amortization				Net
Tax Services:
Customer relationships		$	43,650			$	(18,042	)		$	25,608			$	39,347			$	(14,654	)		$	24,693
Noncompete agreements			22,925				(18,992	)			3,933				21,237				(18,279	)			2,958
Purchased technology			12,500				(815	)			11,685				12,500				—				12,500
Trade name			1,025				(42	)			983				1,025				—				1,025
Business Services:
Customer relationships			143,263				(91,715	)			51,548				142,315				(90,900	)			51,415
Noncompete agreements			32,271				(15,725	)			16,546				31,352				(15,524	)			15,828
Trade name – amortizing			3,291				(2,772	)			519				3,290				(2,430	)			860
Trade name – non-amortizing			55,637				(4,868	)			50,769				55,637				(4,868	)			50,769
Consumer Financial Services:
Customer relationships			293,000				(280,792	)			12,208				293,000				(271,635	)			21,365
Total intangible assets		$	607,562			$	(433,763	)		$	173,799			$	599,703			$	(418,290	)		$	181,413

     Amortization of intangible assets for the three months ended July 31, 2007 and 2006 was $15.5 million and $14.7 million, respectively. Estimated amortization of intangible assets for fiscal years 2008 through 2012 is $45.7 million, $22.1 million, $19.1 million, $17.3 million and $14.6 million, respectively.

4.		Borrowings
		HRB Bank is a member of the Federal Home Loan Bank (FHLB) of Des Moines, which extends credit to member banks based on eligible collateral. At July 31, 2007, HRB Bank had FHLB advance capacity of $499.3 million, and there was $104.0 million outstanding on this facility. Mortgage loans held for investment of $1.2 billion were pledged as collateral on these advances.

     At July 31, 2007, we maintained $2.0 billion in back-up credit facilities to support the commercial paper program and for general corporate purposes. These unsecured committed lines of

credit (CLOCs) have a maturity date of August 2010 and an annual facility fee in a range of six to fifteen basis points per annum, based on our credit ratings. Market conditions have negatively impacted the availability and term of commercial paper. As a result, subsequent to July 31, 2007 we drew a combined $1.2 billion under our $2.0 billion in available CLOCs. These borrowings under the CLOCs were made to provide a more stable source of funds to support our short-term cash needs. We have $633.8 million in outstanding commercial paper as of August 31, 2007, which we anticipate will be refinanced by funds available through the CLOCs. The CLOCs, among other things, require we maintain at least $650.0 million of Adjusted Net Worth, as defined in the agreement, on the last day of any fiscal quarter. We had Adjusted Net Worth of $1.1 billion at July 31, 2007, representing excess stockholders’ equity of $450.0 million. We believe we will continue to be in compliance for the remaining term of the agreement.

5.		Income Taxes
		In June 2006, FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) was issued. The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” The interpretation prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

     We adopted the provisions of FIN 48 on May 1, 2007 and, as a result, recognized a $9.7 million increase in the liability for unrecognized tax benefits resulting in a decrease to retained earnings as of May 1, 2007. Total unrecognized tax benefits as of May 1, 2007 were $133.3 million, of which $89.0 million were tax positions that, if recognized, would impact the effective tax rate.

     We recognize interest and, if applicable, penalties related to unrecognized tax benefits as a component of income tax expense. As of May 1, 2007 we accrued $35.0 million for the potential payment of interest and penalties.

     In the first quarter, we accrued an additional $4.1 million of interest related to our uncertain tax positions. As of July 31, 2007 we had unrecognized tax benefits of $132.2 million. The primary change during the quarter was related to payments made to taxing authorities for settlements of prior year tax positions. We have classified the liability for unrecognized tax benefits, including corresponding accrued interest, as long-term at July 31, 2007, which is included in other noncurrent liabilities on the condensed consolidated balance sheet. We also reclassified income tax refunds due to us totaling $44.6 million to other assets from accrued income taxes as of April 30, 2007.

     Based upon the expiration of statutes of limitations and other factors in several jurisdictions, we believe it is reasonably possible that the total amount of previously unrecognized tax benefits may decrease by approximately $4 million to $5 million within twelve months of July 31, 2007.

     We file a consolidated federal tax return in the United States and income tax returns in various state and foreign jurisdictions. We are no longer subject to U.S. federal income tax audits for years before 1999. The U.S. federal audit for years 1999 through 2003 is in its final stages. The Internal Revenue Service has commenced an audit for the years 2004 and 2005. With respect to our Canadian operations, audits for tax years 1996 through 2001 have been completed and are in the final stages. Tax years 2002 and 2003 are currently under audit. With respect to state and local jurisdictions, with limited exceptions, H&R Block, Inc. and its subsidiaries are no longer subject to income tax audits for years before 1999.

6.		Regulatory Requirements
		Registered Broker-Dealer
		H&R Block Financial Advisors, Inc. (HRBFA) is subject to regulatory requirements intended to ensure the general financial soundness and liquidity of broker-dealers. At July 31, 2007, HRBFA’s net capital of $127.9 million, which was 28.1% of aggregate debit items, exceeded its minimum required net capital of $9.1 million by $118.8 million.

     Pledged securities at July 31, 2007 totaled $61.7 million, an excess of $7.0 million over the margin requirement.

Banking

H&R Block Bank (HRB Bank) and the Company are subject to various regulatory capital guidelines and requirements administered by federal banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on HRB Bank and the consolidated financial statements. All savings associations are subject to the capital adequacy guidelines and the regulatory framework for prompt corrective action. HRB Bank must meet specific capital guidelines that involve quantitative measures of HRB Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. HRB Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. HRB Bank files its regulatory Thrift Financial Report (TFR) on a calendar quarter basis.

     Quantitative measures established by regulation to ensure capital adequacy require HRB Bank to maintain minimum amounts and ratios of tangible equity, total risk-based capital and Tier 1 capital, as set forth in the table below. In addition to these minimum ratio requirements, HRB Bank is required to continually maintain a 12.0% minimum leverage ratio as a condition of its charter-approval order through fiscal year 2009. This condition was extended through fiscal year 2012 as a result of a Supervisory Directive issued on May 29, 2007. See further discussion of the Supervisory Directive below. As of July 31, 2007, HRB Bank’s leverage ratio was 13.2%.

     As of June 30, 2007, our most recent TFR filing with the Office of Thrift Supervision (OTS), HRB Bank was a “well capitalized” institution under the prompt corrective action provisions of the Federal Deposit Insurance Corporation (FDIC). The five capital categories are: (1) “well capitalized” (total risk-based capital ratio of 10%, Tier 1 Risk-based capital ratio of 6% and leverage ratio of 5%); (2) “adequately capitalized”; (3) “undercapitalized”; (4) “significantly undercapitalized”; and (5) “critically undercapitalized.” There are no conditions or events since June 30, 2007 that management believes have changed HRB Bank’s category.

     The following table sets forth HRB Bank’s regulatory capital requirements at June 30, 2007, as calculated in the most recently filed TFR:

																		(dollars in 000s)
																		To Be Well Capitalized
										For Capital Adequacy Under								Prompt Corrective
		Actual								Purposes								Action Provisions
		Amount				Ratio				Amount				Ratio				Amount				Ratio
Total risk-based capital ratio (1)		$	181,237				23.9	%		$	60,628				8.0	%		$	75,786				10.0	%
Tier 1 risk-based capital ratio (2)		$	176,003				23.2	%			n/a				n/a			$	45,471				6.0	%
Tier 1 capital ratio (leverage) (3)		$	176,003				12.3	%		$	171,179				12.0	%		$	71,325				5.0	%
Tangible equity ratio (4)		$	176,003				12.3	%		$	21,397				1.5	%			n/a				n/a

     In conjunction with H&R Block, Inc.’s application with the OTS for HRB Bank, we made commitments as part of our charter approval order (Master Commitment) which included, but were not limited to: (1) a three percent minimum ratio of adjusted tangible capital to adjusted total assets, as defined by the OTS; (2) maintain all HRB Bank capital within HRB Bank in accordance with the submitted three-year business plan; and (3) follow federal regulations surrounding intercompany transactions and approvals. We fell below the three percent minimum ratio at April 30, 2007. We notified the OTS of our failure to meet this requirement, and on May 29, 2007, the OTS issued a Supervisory Directive. We submitted a revised capital plan to the OTS on July 19, 2007, that projects we will regain compliance with the three percent minimum capital requirement by April 30,

2008. The revised capital plan contemplates that we will meet the minimum capital requirement primarily through earnings generated by our normal business operations in fiscal year 2008. The OTS has accepted our revised capital plan. We also fell below the three percent minimum ratio during our first quarter, and had adjusted tangible capital of negative $177.6 million, and a requirement of $168.3 million to be in compliance at July 31, 2007. Normal seasonal operating losses of our Tax and Business Services segments, and operating losses of our discontinued mortgage businesses, are also expected to cause us to be in non-compliance until the end of fiscal year 2008.

     The Supervisory Directive included additional conditions that we will be required to meet in addition to the Master Commitment. The significant additional conditions included in the Supervisory Directive are as follows: (1) requires HRB Bank to extend its compliance with a minimum 12.0% leverage ratio through fiscal year 2012; (2) requires H&R Block, Inc. to comply with the Master Commitment at all times, except for the projected capital levels and compliance with the three percent minimum ratio, as provided in the fiscal year 2008 and 2009 capital adequacy projections presented to the OTS on July 19, 2007; (3) institutes reporting requirements to the OTS quarterly and monthly by the Board of Directors and management, respectively; and (4) requires HRB Bank’s Board of Directors to have an independent chairperson and at least the same number of outside directors as inside directors.

     We have maintained compliance with the Supervisory Directive in fiscal year 2008. However, operating losses of our discontinued operations for the first quarter of fiscal year 2008 were higher than projected in our revised capital plan that was submitted to the OTS. As a result, our capital levels are lower than those projections. Based on our current operating plan, we still expect to be in compliance by April 30, 2008, the original date projected in the capital plan. In order to meet the three percent minimum ratio at April 30, 2008, we do not expect to be in a position to repurchase treasury shares until fiscal year 2009. If we are not in a position to cure deficiencies, and if operating results are below our plan, a resulting failure could impair our ability to repurchase shares of our common stock, acquire businesses or pay dividends.

     Achievement of the capital plan depends on future events and circumstances, the outcome of which cannot be assured. Failure to meet the conditions under the Master Commitment and the Supervisory Directive, including capital levels of H&R Block, Inc. and completion of a planned sale of OOMC by October 31, 2007, could result in the OTS taking further regulatory actions, such as a supervisory agreement, cease-and-desist orders and civil monetary penalties. It is possible that the sale of OOMC may not be completed by October 31, 2007. At this time, the financial impact, if any, of additional regulatory actions cannot be determined.

7.		Commitments and Contingencies
		Changes in the deferred revenue liability related to our Peace of Mind (POM) program are as follows:

						(in 000s)
Three months ended July 31,		2007				2006
Balance, beginning of period		$	142,173			$	141,684
Amounts deferred for new guarantees issued			470				511
Revenue recognized on previous deferrals			(27,237	)			(28,738	)
Balance, end of period		$	115,406			$	113,457

     The following table summarizes certain of our other contractual obligations and commitments:

						(in 000s)
As of		July 31, 2007				April 30, 2007
Commitment to fund Franchise Equity Lines of Credit		$	79,424			$	79,628
Media advertising purchase obligation			37,749				37,749
Contingent business acquisition obligations			19,691				19,891

     On November 1, 2006 we entered into an agreement to purchase $57.2 million in media advertising between November 1, 2006 and June 30, 2009. We expect to make payments totaling $20.6 million and $17.2 million during fiscal years 2008 and 2009, respectively.

     We routinely enter into contracts that include embedded indemnifications that have characteristics similar to guarantees, including obligations to protect counterparties from losses

arising from the following: (a) tax, legal and other risks related to the purchase or disposition of businesses; (b) penalties and interest assessed by Federal and state taxing authorities in connection with tax returns prepared for clients; (c) indemnification of our directors and officers; and (d) 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 term of indemnities may vary and in many cases is 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 that such claims will not be successfully asserted, we believe the fair value of these guarantees and indemnifications is not material as of July 31, 2007.

8.		Litigation and Related Contingencies
		We have been named as a defendant in numerous lawsuits throughout the country regarding our refund anticipation loan programs (collectively, “RAL Cases”). The RAL Cases have involved a variety of legal theories asserted by plaintiffs. These theories include allegations that, among other things, disclosures in the RAL applications were inadequate, misleading and untimely; the RAL interest rates were usurious and unconscionable; we did not disclose that we would receive part of the finance charges paid by the customer for such loans; untrue, misleading or deceptive statements in marketing RALs; breach of state laws on credit service organizations; breach of contract, unjust enrichment, unfair and deceptive acts or practices; violations of the federal Racketeer Influenced and Corrupt Organizations Act; violations of the federal Fair Debt Collection Practices Act and unfair competition regarding debt collection activities; and that we owe, and breached, a fiduciary duty to our customers in connection with the RAL program.

     The amounts claimed in the RAL Cases have been very substantial in some instances. We have successfully defended against numerous RAL Cases, some of which were dismissed on our motions for dismissal or summary judgment, and others were dismissed voluntarily by the plaintiffs after denial of class certification. Other cases have been settled, with one settlement resulting in a pretax expense of $43.5 million in fiscal year 2003 (the “Texas RAL Settlement”) and other settlements resulting in a combined pretax expense in fiscal year 2006 of $70.2 million (the “2006 Settlements”).

     We believe we have meritorious defenses to the remaining RAL Cases and we intend to defend them vigorously. There can be no assurances, however, as to the outcome of the pending RAL Cases individually or in the aggregate. Likewise, there can be no assurances regarding the impact of the RAL Cases on our financial statements. The following is updated information regarding the pending RAL Cases that are attorney general actions or class actions or putative class actions for which there have been significant developments during the fiscal quarter ended July 31, 2007:

     Lynne A. Carnegie, et al. v. Household International, Inc., H&R Block, Inc., et al., (formerly Joel E. Zawikowski, et al. v. Beneficial National Bank, H&R Block, Inc., Block Financial Corporation, et al.) Case No. 98 C 2178, United States District Court for the Northern District of Illinois, Eastern Division, instituted on April 18, 1998. This case is one of the cases in the 2006 Settlements. On April 19, 2006, we entered into a settlement agreement regarding this case, subject to final court approval. The settlement was approved by the court on August 28, 2006. The settlement is now final.

     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 court decertified the class on December 31, 2003. The Pennsylvania appellate court subsequently reversed the trial court’s decertification decision. On September 26, 2006, the Pennsylvania Supreme Court reversed the appellate court’s reversal of the trial court’s decision to decertify the class. On June 4, 2007, the appellate court affirmed its earlier decision. The Company is currently seeking review of the appellate court’s decision by the Pennsylvania Supreme Court.

     Lorie J. Marshall, et al. v. H&R Block Tax Services, Inc., et al., Civil Action 2003L000004, in the Circuit Court of Madison County, Illinois, is a class action case filed on January 18, 2002, that was granted class certification on August 27, 2003. Plaintiffs’ claims consist of five counts relating to the POM program under which the applicable tax return preparation subsidiary assumes liability for additional tax assessments attributable to tax return preparation error. The plaintiffs allege that the sale of POM guarantees constitutes (i) statutory fraud by selling insurance without a license, (ii) an unfair trade practice, by omission and by “cramming” (i.e., charging customers for the guarantee even though they did not request it or want it), and (iii) a breach of fiduciary duty. In August 2003, the court certified the plaintiff classes consisting of all persons who from January 1, 1997 to final judgment (i) were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member; (ii) reside in certain class states and were charged a separate fee for POM by “H&R Block” or a defendant H&R Block class member not licensed to sell insurance; and (iii) had an unsolicited charge for POM posted to their bills by “H&R Block” or a defendant H&R Block class member. Persons who received the POM guarantee through an H&R Block Premium office and persons who reside in Alabama are excluded from the plaintiff class. The court also certified a defendant class consisting of any entity with names that include “H&R Block” or “HRB,” or are otherwise affiliated

or associated with H&R Block Tax Services, Inc., and that sold or sells the POM product. The trial court subsequently denied the defendants’ motion to certify class certification issues for interlocutory appeal. Discovery is proceeding. No trial date has been set.

     There is one other putative class action pending against us in Texas that involves the POM guarantee. This case is being tried before the same judge that presided over the Texas RAL Settlement, involves the same plaintiffs’ attorneys that are involved in the Marshall litigation in Illinois, and contains similar allegations. No class has been certified in this case.

     We believe the claims in the POM actions are without merit, and we intend to defend them vigorously. The amounts claimed in the POM actions are substantial, however, and there can be no assurances as to the outcome of these pending actions individually or in the aggregate. Likewise, there can be no assurances regarding the impact of these actions on our consolidated financial statements.

     On March 15, 2006, the New York Attorney General filed a lawsuit in the Supreme Court of the State of New York, County of New York (Index No. 06/401110) entitled The People of New York v. H&R Block, Inc. and H&R Block Financial Advisors, Inc. The complaint alleged fraudulent business practices, deceptive acts and practices, common law fraud and breach of fiduciary duty with respect to the Express IRA product and sought equitable relief, disgorgement of profits, damages and restitution, civil penalties and punitive damages. On July 12, 2007, the Supreme Court of the State of New York issued a ruling that dismissed all defendants other than H&R Block Financial Advisors, Inc. and the claims of common law fraud. We intend to defend this case vigorously, but there are no assurances as to its outcome.

     In addition to the New York Attorney General action, a number of civil actions were filed against us concerning the Express IRA matter, the first of which was filed on March 17, 2006. Except for two cases pending in state court, all of the civil actions have been consolidated by the panel for Multi-District Litigation into a single action styled In re H&R Block, Inc. Express IRA Marketing Litigation in the United States District Court for the Western District of Missouri. We intend to defend these cases vigorously, but there are no assurances as to their outcome.

     On April 6, 2007, a putative class action styled In re H&R Block Securities Litigation was filed against the Company and certain of its officers in the United States District Court for the Western District of Missouri. The complaint alleges, among other things, deceptive, material and misleading financial statements, failure to prepare financial statements in accordance with generally accepted accounting principles and concealment of the potential for lawsuits stemming from the allegedly fraudulent nature of the Company’s operations. The complaint seeks unspecified damages and equitable relief. We intend to defend this litigation vigorously, but there are no assurances as to its outcome.

     As reported previously, the NASD brought charges against HRBFA regarding the sale by HRBFA of Enron debentures in 2001. A hearing for this matter was concluded in August 2007, with post-hearing briefs to be submitted in October 2007. We intend to defend the NASD charges vigorously, although there can be no assurances regarding the outcome and resolution of the matter.

     As part of an industry-wide review, the IRS is investigating tax-planning strategies that certain RSM McGladrey (RSM) clients utilized during fiscal years 2000 through 2003. Specifically, the IRS is examining these strategies to determine whether RSM complied with tax shelter reporting and listing regulations and whether such strategies were abusive as defined by the IRS. If the IRS were to determine that RSM did not comply with the tax shelter reporting and listing regulations, it might assess fines or penalties against RSM. Moreover, if the IRS were to determine that the tax planning strategies were inappropriate, clients that utilized the strategies could face penalties and interest for underpayment of taxes. Some of these clients are seeking or may attempt to seek recovery from RSM. There can be no assurance regarding the outcome and resolution of this matter.

     RSM EquiCo, Inc., a subsidiary of RSM, is a party to a putative class action filed on July 11, 2006 and entitled Do Right’s Plant Growers v. RSM EquiCo, Inc., RSM McGladrey, Inc., H&R Block, Inc. and Does 1-100, inclusive, Case No. 06 CC00137, in the California Superior Court, Orange County. The complaint contains allegations regarding business valuation services provided by RSM EquiCo, Inc., including fraud, negligent misrepresentation, breach of contract, breach of implied covenant of good faith and fair dealing, breach of fiduciary duty and unfair competition and seeks unspecified

damages, restitution and equitable relief. There can be no assurance regarding the outcome and resolution of this matter.

     We have from time to time been party to investigations, claims and lawsuits not discussed herein arising out of our business operations. These investigations, claims and lawsuits include actions by state attorneys general, other state regulators, individual plaintiffs, and cases in which plaintiffs seek to represent a class of similarly situated customers. The amounts claimed in these claims and lawsuits are substantial in some instances, and the ultimate liability with respect to such litigation and claims is difficult to predict. Some of these investigations, claims and lawsuits pertain to RALs, the origination and servicing of mortgage loans, the electronic filing of customers’ income tax returns, the POM guarantee program, and our Express IRA program and other investment products and RSM EquiCo, Inc. business valuation services. We believe we have meritorious defenses to each of these claims, and we are defending or intend to defend them vigorously, although there is no assurance as to their outcome. 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 adverse effect on our consolidated financial statements.

     In addition to the aforementioned types of cases, we are parties to claims and lawsuits that we consider to be ordinary, routine litigation incidental to our business, including claims and lawsuits (Other Claims) concerning investment products, the preparation of customers’ income tax returns, the fees charged customers for various products and services, losses incurred by customers with respect to their investment accounts, relationships with franchisees, denials of mortgage loans, contested mortgage foreclosures, other aspects of the mortgage business, intellectual property disputes, employment matters and contract disputes. We believe we have meritorious defenses to each of the Other Claims, and we are defending them vigorously. 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 adverse effect on our consolidated financial statements.

9.		Segment Information
		Information concerning our operations by reportable operating segment is as follows:

						(in 000s)
Three months ended July 31,		2007				2006
Revenues:
Tax Services		$	69,863			$	65,658
Business Services			192,823				195,457
Consumer Financial Services			114,372				78,829
Corporate			4,151				2,826
		$	381,209			$	342,770
Pretax income (loss):
Tax Services		$	(172,289	)		$	(153,054	)
Business Services			(1,906	)			(6,967	)
Consumer Financial Services			6,206				(3,069	)
Corporate			(15,591	)			(30,884	)
Loss from continuing operations before tax benefit		$	(183,580	)		$	(193,974	)

     As of July 31, 2007, we continued to meet the criteria requiring us to present the related financial results of OOMC, HRBMC and other smaller lines of business as discontinued operations and the assets and liabilities of the businesses being sold as held-for-sale in the condensed consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations. See note 11 for additional information.

10.		New Accounting Pronouncements
		In February 2007, Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115,” (SFAS 159), was issued. This standard allows a company to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities on a

contract-by-contract basis, with changes in fair value recognized in earnings. The provisions of this standard are effective as of the beginning of our fiscal year 2009. We are currently evaluating what effect the adoption of SFAS 159 will have on our consolidated financial statements.

     In September 2006, Statement of Financial Accounting Standards No. 157, “Fair Value Instruments,” (SFAS 157), was issued. The provisions of this standard include guidelines about the extent to which companies measure assets and liabilities at fair value, the effect of fair value measurements on earnings, and establishes a fair value hierarchy that prioritizes the information used in developing assumptions used when valuing an asset or liability. The standard also requires increased disclosure of these fair value estimates. The provisions of this standard are effective as of the beginning of our fiscal year 2009. We are currently evaluating what effect the adoption of SFAS 157 will have on our consolidated financial statements.

     In September 2006, Emerging Issues Task Force Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements” (EITF 06-4) was issued. EITF 06-4 requires the recognition of a liability for an agreement with an employee to provide future postretirement benefits, as this obligation is not effectively settled upon entering into an insurance arrangement. The provisions of this standard are effective as of the beginning of our fiscal year 2009. We are currently evaluating what effect the adoption of EITF 06-4 will have on our consolidated financial statements.

     In March 2006, Statement of Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets – An Amendment of FASB Statement No. 140,” (SFAS 156), was issued. The provisions of this standard require mortgage servicing rights to be initially valued at fair value. SFAS 156 allows servicers to choose to subsequently measure their servicing rights at fair value or to continue using the “amortization method” under SFAS 140. We adopted SFAS 156 on May 1, 2007. Upon adoption we identified mortgage servicing rights (MSRs) relating to all existing residential mortgage loans as a class of servicing rights and elected to continue to use the “amortization method” for these MSRs. Presently, this class represents all of our MSRs. See note 11 for additional information on our MSRs. The adoption of SFAS 156 did not have a material impact on our condensed consolidated financial statements.

     In February 2006, Statement of Financial Accounting Standards No. 155, “Accounting for Certain Hybrid Instruments – An Amendment of FASB Statements No. 133 and 140” (SFAS 155), was issued. The provisions of this standard establish a requirement to evaluate all newly acquired interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. The standard permits a hybrid financial instrument required to be bifurcated to be accounted for in its entirety if the holder irrevocably elects to measure the hybrid financial instrument at fair value, with changes in fair value recognized currently in earnings. We adopted SFAS 155 on May 1, 2007. Our residual interests typically have interests in derivative instruments embedded within the securitization trusts, which were previously excluded from evaluation. Concurrent with the adoption of SFAS 155, we elected to account for all newly-acquired residual interests on a fair value basis as trading securities, with changes in fair value recorded in earnings in the period in which the change occurs. Prior to adoption, we accounted for our residual interests as AFS securities with unrealized gains recorded in other comprehensive income. For residual interests recorded prior to the adoption of SFAS 155, we continue to record unrealized gains as a component of other comprehensive income. The adoption of SFAS 155 did not have a material impact on our condensed consolidated financial statements.

     As discussed in note 5, we adopted the provisions of FIN 48 effective May 1, 2007.

11.		Discontinued Operations
		On April 19, 2007, we entered into an agreement to sell OOMC to Cerberus Capital Management for cash consideration approximately equal to the fair value of the adjusted tangible net assets of OOMC, as defined in the agreement, at closing less $300.0 million. The agreement provides for H&R Block, Inc. to receive one-half of OOMC’s net income from its origination business for the 18 months

following the closing, up to a maximum of $300.0 million, but no less than zero. The agreement is subject to various closing conditions and may be terminated by either party if the transaction does not close by December 31, 2007. These closing conditions include, among other matters: (1) maintenance of at least $8.0 billion of warehouse lines; (2) existence of at least $2.0 billion of loans in the warehouse facilities at the date of closing, all originated within the prior 60 days; (3) the lack of any material adverse events or conditions; (4) OOMC have servicer ratings of at least RPS2 by Fitch, SQ2 by Moody's and Above Average by S&P; (5) agreed upon regulatory and other approvals and consents be obtained; and (6) we provide audited financial statements of OOMC for the year ended April 30, 2007 by July 31, 2007, with the lack of a going concern explanatory paragraph related to OOMC, except to the extent necessary as a result of specified permitted conditions. We are currently not in compliance with certain closing conditions required by this agreement and do not believe we will be able to regain compliance with such closing conditions or maintain compliance through the anticipated closing date. See additional discussion of recent developments in note 1. In conjunction with this plan, we also announced we would terminate the operations of HRBMC, a wholly-owned subsidiary of OOMC.

     During fiscal year 2007, we also committed to a plan to sell two smaller lines of business and completed the wind-down of one other line of business, all of which were previously reported in our Business Services segment. One of these businesses was sold during the three months ended July 31, 2007. Additionally, during fiscal year 2007, we completed the wind-down of our tax operations in the United Kingdom, which were previously reported in Tax Services. As of July 31, 2007, we continued to meet the criteria requiring us to present the related financial results of these businesses as discontinued operations and the assets and liabilities of the businesses being sold as held-for-sale and in the condensed consolidated financial statements. All periods presented have been reclassified to reflect our discontinued operations.

Financial Statement Presentation

We recorded impairments relating to the disposition of our mortgage business during the three months ended July 31, 2007 of $21.7 million. These amounts primarily relate to the value of fixed assets included in assets held-for-sale. We also recorded impairments relating to other discontinued businesses of $1.5 million during the current quarter. Additionally, during fiscal year 2007 we recorded impairments relating to the disposition of our mortgage businesses of $345.8 million, including the full impairment of associated goodwill equal to $152.5 million. Overhead costs previously allocated to discontinued businesses, which totaled $1.3 million and $3.0 million for the three months ended July 31, 2007 and 2006, respectively, are now included in continuing operations.

     The major classes of assets and liabilities reported as held-for-sale are as follows:

						(in 000s)
		July 31, 2007				April 30, 2007
Cash and cash equivalents		$	25,702			$	65,019
Cash and cash equivalents – restricted			15,002				43,754
Residual interests in securitizations – trading			27,601				72,691
Mortgage loans held for sale			432,173				222,810
Deferred tax assets, net – current			53,761				53,761
Servicing and related assets			510,157				445,354
Prepaid expenses and other current assets, net			46,031				121,078
Current assets held for sale		$	1,110,427			$	1,024,467
Beneficial interest in Trusts		$	54,450			$	41,057
Residual interests in securitizations – AFS			62,714				90,283
Mortgage servicing rights			232,714				253,067
Deferred tax assets, net – noncurrent			263,762				245,798
Other assets			88,165				92,287
Noncurrent assets held for sale		$	701,805			$	722,492
Accounts payable, accrued expenses and deposits		$	493,165			$	370,226
Other liabilities			257,617				245,147
Current liabilities directly associated with assets held for sale		$	750,782			$	615,373

     The financial results of discontinued operations are as follows:

						(in 000s)
Three months ended July 31,		2007				2006
Revenue:
Gains (losses) on sales of mortgage assets, net		$	(242,015	)		$	64,606
Interest income			15,099				15,300
Loan servicing revenue			97,399				108,924
Other			6,127				9,872
			(123,390	)			198,702

						(in 000s)
Three months ended July 31,		2007				2006
Loss from operations before income tax benefit			(312,168	)			(24,685	)
Impairment related to the disposition of businesses			(23,229	)			—
Pretax loss			(335,397	)			(24,685	)
Income tax benefit			(142,640	)			(11,147	)
Net loss from discontinued operations		$	(192,757	)		$	(13,538	)

Mortgage Banking Activities

We originate mortgage loans and sell most non-prime loans the same day the loans are funded to qualifying special purpose entities (QSPEs or Trusts). The Trusts are not consolidated. The sale is recorded in accordance with Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (SFAS 140). The Trusts purchase the loans from us using seven warehouse facilities. As a result of the loan sales to the Trusts, we remove the mortgage loans from our balance sheet and record the gain or loss on the sale, cash proceeds, MSRs, repurchase reserves and a beneficial interest in Trusts, which represents our residual interest in the ultimate expected outcome from the disposition of the loans by the Trusts. The total principal amount of mortgage loans held by the Trusts as of July 31, 2007 and April 30, 2007 was $2.1 billion and $1.5 billion, respectively. The beneficial interest in Trusts was $54.5 million and $41.1 million at July 31, 2007 and April 30, 2007, respectively.

     The Trusts, in response to the exercise of a put option by the third-party beneficial interest holders, either sell the loans directly to third-party investors or back to us to pool the loans for securitization. The decision of the beneficial interest holders to complete a loan sale or a securitization is dependent on market conditions. If the Trusts execute loan sales, we receive cash for our beneficial interest in Trusts. In a securitization transaction, the Trusts transfer the loans to one of our consolidated bankruptcy remote subsidiaries, and we transfer our beneficial interest in Trusts and the loans to a securitization trust. The securitization trust meets the definition of a QSPE and is therefore not consolidated. The securitization trust issues bonds, which are supported by the cash flows from the pooled loans, to third-party investors. We retain an interest in the loans in the form of a trading residual interest and usually assume the first risk of loss for credit losses in the loan pool. As the cash flows of the underlying loans and market conditions change, the value of these residual interests may also change, resulting in either additional gains or impairment of the value of the residual interests. These residual interests are classified as trading securities along with any newly-acquired residual interests from NIM transactions beginning May 1, 2007. We held $27.6 million of trading residual interests as of July 31, 2007 and $72.7 million as of April 30, 2007.

     Activity related to trading residual interests in securitizations consists of the following:

(in 000s)
Three months ended July 31,		2007				2006
Balance, beginning of period		$	72,691			$	—
Additions (resulting from securitization of mortgage loans)			42,458				63,424
Cash received			—				(4,546	)
Accretion			—				909
Change in fair value			(674	)			(461	)
			114,475				59,326
Residuals securitized in NIM transactions			(114,475	)			—
Additions (resulting from NIM transactions)			41,705				—
Accretion			2,651				—
Change in fair value			(16,755	)			—
Balance, end of period		$	27,601			$	59,326

     We adopted SFAS 155 on May 1, 2007 and concurrently elected to account for all newly-acquired residual interests on a fair value basis, with changes in fair value recorded in earnings in the period in which the change occurs. Residual interests existing prior to the adoption of SFAS 155 will continue to be accounted for with unrealized gains recorded in other comprehensive income.

     Activity related to available-for-sale (AFS) residual interests in securitizations consists of the following:

(in 000s)
Three months ended July 31,		2007				2006
Balance, beginning of period		$	90,283			$	159,058
Cash received			(487	)			(4,567	)
Accretion			6,283				12,600
Impairments of fair value			(32,849	)			(17,266	)
Change in unrealized holding gains arising during the period			(516	)			(4,046	)
Balance, end of period		$	62,714			$	145,779

     Cash flows from AFS residual interests of $0.5 million and $4.6 million were received from the securitization trusts for the three months ended July 31, 2007 and 2006, respectively, and are included in investing activities of discontinued operations in the condensed consolidated statements of cash flows.

     The following transactions were treated as non-cash investing activities in the condensed consolidated statement of cash flows:

(in 000s)
Three months ended July 31,		2007				2006
Residual interest mark-to-market		$	(383	)		$	531

     For residual interests recorded prior to the adoption of SFAS 155, aggregate unrealized gains on AFS residual interests not yet recognized in income totaled $0.8 million at July 31, 2007, compared to $1.3 million at April 30, 2007. These unrealized gains are recorded net of deferred taxes in other comprehensive income, and recognized in income either through accretion or upon further securitization or sale of the related residual interest. See additional discussion of our adoption of SFAS 155 in note 10.

     Activity related to MSRs, which are initially measured at fair value and subsequently amortized and assessed for impairment, consists of the following:

(in 000s)
Three months ended July 31,		2007				2006
Balance, beginning of period		$	253,067			$	272,472
Additions			23,290				50,122
Amortization			(43,625	)			(47,328	)
Impairment of fair value			(18	)			—
Balance, end of period		$	232,714			$	275,266

     Estimated amortization of MSRs for fiscal years 2008 through 2012 is $98.8 million, $73.6 million, $34.2 million, $14.1 million and $5.5 million, respectively. The fair value of MSRs at July 31, 2007 and April 30, 2007 was $354.8 million and $397.5 million, respectively.

     In conjunction with our adoption of SFAS 156, we identified all of our residential mortgage loans as a class of servicing rights and elected to continue the amortization method. See additional discussion of our adoption of SFAS 156 in note 10. Servicing fees earned during the three months ended July 31, 2007 and 2006 totaled $98.9 million and $102.6 million, respectively, and are included in discontinued operations on our condensed consolidated income statements.

     As part of our loan servicing responsibilities, we are required to advance funds to cover delinquent scheduled principal and interest payments to security holders, as well as to cover delinquent tax and insurance payments and other costs required to protect the investors’ interest in the collateral securing the loans. Generally, servicing advances are recoverable from either the mortgagor, the insurer of the loan or the investor through the non-recourse provision of the loan servicing contract.

     The key weighted average assumptions we used to estimate the cash flows and values of the residual interests initially recorded during the three months ended July 31, 2007 and 2006 are as follows:

Three months ended July 31,		2007				2006
Estimated credit losses			6.36	%			3.51	%
Discount rate			28.00	%			18.00	%
Variable returns to third-party beneficial interest holders		LIBOR forward curve at closing date

     The key weighted average assumptions we used to estimate the cash flows and values of the residual interests and MSRs at July 31, 2007 and April 30, 2007 are as follows:

		July 31, 2007				April 30, 2007
Estimated credit losses – residual interests			5.13	%			5.04	%
Discount rate – residual interests			47.00	%			24.82	%
Discount rate – MSRs			20.00	%			20.00	%
Variable returns to third-party beneficial interest holders		LIBOR forward curve at valuation date

     Estimated credit losses in the table above include residual interests from all fiscal years with outstanding underlying loan balances using unpaid principal balances as part of the weighted average calculation. See credit losses table below for detailed information by fiscal year.

     We originate both adjustable- and fixed-rate mortgage loans. A key assumption used to estimate the cash flows and values of the residual interests and MSRs is average annualized prepayment speeds. Prepayment speeds include voluntary prepayments, involuntary prepayments and scheduled principal payments. Prepayment rate assumptions used during the current fiscal quarter are as follows:

						Months Outstanding After
		Prior to Initial				Initial Rate Reset Date
		Rate Reset Date				Zero - 3				Remaining Life
Adjustable rate mortgage loans:
With prepayment penalties			27	%			70	%			28	%
Without prepayment penalties			36	%			51	%			24	%
Fixed rate mortgage loans:
With prepayment penalties			25	%			40	%			22	%

     For fixed-rate mortgages without prepayment penalties, we use an average prepayment rate of 20% over the life of the loans. Prepayment rate is projected based on actual paydown including voluntary, involuntary and scheduled principal payments.

     Expected static pool credit losses are as follows:

		Mortgage Loans Securitized in Fiscal Year
		Prior to 2002				2003				2004				2005				2006				2007				2008
As of:
July 31, 2007			5.11	%			2.57	%			3.45	%			5.48	%			6.79	%			6.41	%			6.36	%
April 30, 2007			5.11	%			2.57	%			3.45	%			5.48	%			6.79	%			6.41	%			—
April 30, 2006			4.22	%			2.13	%			2.18	%			2.48	%			3.05	%			—				—
April 30, 2005			4.01	%			2.08	%			2.30	%			2.83	%			—				—				—

     Static pool credit losses are calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets.

     At July 31, 2007, the sensitivities of the current fair value of the residual interests and MSRs to 10% and 20% adverse changes in the above key assumptions are as presented in the following table. These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also in this table, the effect of a variation of a particular assumption on the fair value of the retained interest is calculated without changing any other assumptions; in reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.

(dollars in 000s)
		Residential Mortgage Loans
						Beneficial Interest
		Residuals				in Trusts				MSRs
Carrying amount/fair value		$	90,315			$	54,450			$	232,714
Weighted average remaining life (in years)			5.9				2.5				1.4
Dollar impact on fair value:
Prepayments (including defaults):
Adverse 10%		$	(4,569	)		$	364			$	(18,790	)
Adverse 20%			(1,286	)			704				(35,717	)
Credit losses:
Adverse 10%		$	(23,639	)		$	(2,007	)		Not applicable
Adverse 20%			(42,053	)			(3,978	)		Not applicable
Discount rate:
Adverse 10%		$	(8,623	)		$	(1,229	)		$	(7,917	)
Adverse 20%			(16,018	)			(2,413	)			(15,338	)
Variable interest rates:
Adverse 10%		$	2,512			$	(12,455	)		Not applicable
Adverse 20%			4,882				(24,973	)		Not applicable

     Increases in prepayment rates can generate a positive impact to fair value when reductions in estimated credit losses and increases in prepayment penalties exceed the adverse impact to accretion from accelerating the life of the residual interest. Given the current market volatility, the change in credit losses or discount rate could exceed the ranges in the table above and result in little or no value to the residual interests.

     Mortgage loans that have been securitized and mortgage loans held for sale at July 31, 2007 and April 30, 2007, past due sixty days or more and the related credit losses incurred are presented below:

(in 000s)
		Total Principal								Principal Amount of
		Amount of Loans								Loans 60 Days or								Credit Losses
		Outstanding								More Past Due								(net of recoveries)
		July 31,				April 30,				July 31,				April 30,				Three months ended
		2007				2007				2007				2007				July 31, 2007				April 30, 2007
Securitized mortgage loans		$	20,616,376			$	18,434,940			$	1,957,164			$	1,383,832			$	49,059			$	41,235
Mortgage loans in warehouse Trusts			2,062,295				1,456,078				—				—				—				—
Mortgage loans held for sale			547,287				295,208				435,254				202,941				80,825				104,972
Total loans		$	23,225,958			$	20,186,226			$	2,392,418			$	1,586,773			$	129,884			$	146,207

     The significant increase in non-prime delinquencies and defaults, combined with declining residential real estate prices, has created substantial uncertainty among marketplace participants regarding the ultimate credit losses expected to be realized on securitized loans. We previously considered these factors in estimating our credit losses and our analysis of loss data for the three months ended July 31, 2007 did not indicate that we should increase our credit loss assumption. However, declining prices in the marketplace reflected the increasing levels of uncertainty. Because of the difficulty in discerning whether marketplace participants actually expect higher credit losses, demand a higher risk premium, or both, we elected to reflect the increased risk perceived by marketplace participants by substantially increasing the discount rate used in our residual valuations to 47%, rather than by increasing the credit loss assumption. We believe that the increase in the discount rate results in residual values that are reflective of current market prices.

Derivative Instruments

A summary of our derivative instruments as of July 31, 2007 and April 30, 2007, and gains or losses incurred during the three months ended July 31, 2007 and 2006 is as follows:

(in 000s)
										Gain (Loss) for the Three
		Asset (Liability) Balance at								Months Ended July 31,
		July 31, 2007				April 30, 2007				2007				2006
Rate-lock equivalents		$	(8,488	)		$	(987	)		$	(7,501	)		$	7,745
Interest rate swaps			(5,206	)			10,774				2,648				13,179
Put options on Eurodollar futures			—				1,212				942				(38	)
Prime short sales			(107	)			75				98				(561	)
Forward loan sale commitments			26,072				—				26,072				(7,082	)
		$	12,271			$	11,074			$	22,259			$	13,243

     The gain on our forward loan sale commitments offsets a related loss on the impairment of our beneficial interest in Trusts.

     The notional amount of interest rate swaps to which we were a party at July 31, 2007 and April 30, 2007 was $2.6 billion and $2.8 billion, respectively, with a weighted average duration at each date of two years. At July 31, 2007 the notional value and the contract values of our forward loan sale commitments were $628.1 million and $632.0 million, respectively. At April 30, 2007 we had no forward loan sale commitments.

     None of our derivative instruments are designated for hedge accounting treatment as of July 31, 2007 or April 30, 2007.

Commitments and Contingencies

The following table summarizes certain of our contractual obligations and commitments related to our discontinued operations:

(in 000s)
As of		July 31, 2007				April 30, 2007
Commitment to fund mortgage loans		$	1,745,843			$	2,374,938
Commitment to sell mortgage loans			628,080				—

     We have commitments to fund mortgage loans to customers as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. External market forces impact the probability of commitments being exercised, and therefore, total commitments outstanding do not necessarily represent future cash requirements. Of the $1.7 billion of commitments to fund mortgage loans at July 31, 2007, all but $242.5 million were repriced to higher interest rates before funding in August 2007. We expect the majority of the repriced loans will not be funded.

     In the normal course of business, we maintain recourse with standard representations and warranties customary to the mortgage banking industry. Violations of these representations and warranties, such as early payment defaults by borrowers, may require us to repurchase loans previously sold. Repurchased loans are normally sold in subsequent sale transactions. The following table summarizes our loan repurchase activity:

(dollars in 000s)
		Three months ended July 31,								Fiscal year ended
		2007				2006				April 30, 2007
Loans repurchased (1)		$	193,640			$	92,338			$	989,992
Repurchase reserves added during period		$	157,296			$	92,737			$	388,733
Repurchase reserves added as a percent of originations			4.79	%			1.15	%			1.44	%

     A liability has been established related to the potential loss on repurchase of loans previously sold of $72.2 million and $38.4 million at July 31, 2007 and April 30, 2007, respectively. On an ongoing basis, we monitor the adequacy of our repurchase liability, which is established upon the initial sale of the loans, and is included in current liabilities held-for-sale in the condensed consolidated balance sheets. During the quarter ended July 31, 2007, we experienced higher early payment defaults, resulting in an increase in actual and expected loan repurchase activity. In establishing our reserves, we’ve assumed all loans that are currently delinquent and subject to contractual repurchase terms will be repurchased, and that approximately 4% of loans previously sold but not yet subject to contractual repurchase terms will be repurchased. Based on historical experience, we assumed an average 38% loss severity at July 31, 2007, compared to 26% at April 30, 2007, on all loans repurchased and expected to be repurchased. The increase in our loan repurchase liability was primarily due to the increase in our loss severity assumption. At July 31, 2007, we had recorded repurchase reserves to cover estimated future losses from loan repurchase obligations on $178.9 million of outstanding loans.

     OOMC has guaranteed up to a maximum amount equal to approximately 10% of the aggregate principal balance of mortgage loans held by the Trusts before ultimate disposition of the loans by the Trusts. This obligation can be called upon in the event adequate proceeds are not available from the sale of the mortgage loans to satisfy the current or ultimate payment obligations of the Trusts. We have not funded any amounts under this guarantee, however we have provided additional margin as the fair value of the loans has declined and subsequently written the beneficial interest in Trusts down to fair value. The total principal amount of Trust obligations outstanding as of July 31, 2007, April 30, 2007 and July 31, 2006 was $2.1 billion, $1.5 billion and $4.2 billion, respectively. The fair value of mortgage loans held by the Trusts as of July 31, 2007, April 30, 2007 and July 31, 2006 was $2.0 billion, $1.5 billion and $4.3 billion, respectively. At July 31, 2007 and April 30, 2007 we recorded liabilities of $15.0 million and $30,000, respectively, for the estimated fair value of this guarantee obligation, which are included in current liabilities held-for-sale in the condensed consolidated balance sheets. Under the warehouse agreements, we may be required to provide funds in the event of declining loan values, but only to the extent of the 10% guaranteed amount. Funds provided as a result of declining loan values at July 31, 2007 and 2006 totaled $173.0 million and $21.1 million, respectively. Of the amount provided as of July 31, 2007, $169.0 million relates to our off-balance sheet warehouse facilities and is included in the beneficial interest in Trusts while the remaining $4.0 million relates to our on-balance sheet facility. At July 31, 2006, all the funds provided were included in the beneficial interest in Trusts.

Warehouse Facilities

Substantially all non-prime mortgage loans we originate are sold daily to the Trusts. The Trusts purchase the loans from us using committed off-balance sheet warehouse facilities, arranged by us, totaling $7.5 billion in the aggregate. We also had an on-balance sheet facility with capacity of $500.0 million, as discussed below. These facilities are subject to various OOMC performance triggers, limits and financial covenants, including tangible net worth, income and leverage ratios and may be subject to margin calls. We hold an interest in the Trusts equal to the difference between the fair value of the assets and cash proceeds, adjusted for contractual advance rates, received from the Trusts. In addition to the margin call feature, loans sold to the Trust are subject to repurchase if certain criteria are not met, including loan default provisions. Unfavorable fluctuations in loan value are guaranteed up to 10% of the original fair value. As of July 31, 2007, additional uncommitted facilities of $2.0 billion were also potentially available, subject to counterparty approval.

     One warehouse line was amended to remove a “minimum net income” financial covenant, which required OOMC to maintain a cumulative minimum net income of at least $1 for four consecutive fiscal quarters. As a result, OOMC now has $4.0 billion in committed warehouse facilities available, one without the minimum net income financial covenant and one with a waiver of the minimum net income financial covenant through at least April 25, 2008. At our projected origination levels, we estimate we would only need between $3.0 billion and $4.0 billion of available warehouse capacity at any given time. However, the sale of OOMC is subject to various closing conditions, including that OOMC maintain at least $8.0 billion of total capacity in its warehouse facilities throughout the period to the closing date, of which at least $2.0 billion is to be in the form of unused capacity at the closing date. At July 31, 2007, OOMC did not meet the minimum net income financial covenant contained in certain of its committed warehouse facilities. OOMC obtained waivers of the minimum net income financial covenants from warehouse facility providers as needed, to comply with the closing conditions of the sale of OOMC. These waivers extend through various dates as discussed below. If we do not obtain extensions of each facility and waiver that expires before completing the sale of OOMC, or replace existing capacity, we would be in violation of this closing condition.

     Committed warehouse facilities and waivers, where applicable, of the minimum net income financial covenant obtained by OOMC expire as follows:

(dollars in 000s)
Facility Expiration Date		Waiver Expiration Date		Total Capacity				Outstanding Loans
October 2, 2007		October 2, 2007		$	1,000,000			$	402,068
October 2, 2007		September 30, 2007			500,000	(1)			9,157
October 31, 2007		N/A (2)			250,000				217,388
November 9, 2007		September 30, 2007			1,000,000				277,987
January 15, 2008		January 15, 2008			500,000				314,979
January 18, 2008		October 30, 2007			750,000				95,775
April 25, 2008		April 25, 2008			2,000,000				332,922
June 12, 2008		N/A (2)			2,002,000				431,899
				$	8,002,000			$	2,082,175

     During fiscal year 2007, we amended our warehouse facility with Citigroup Global Markets Realty Corp (Citigroup) to split OOMC’s existing warehouse financing arrangement with Citigroup into two separate warehouse facilities, one of which is an on-balance sheet facility with capacity of $500.0 million that may be used to fund delinquent and repurchased loans, and the other an off-balance sheet facility. Loans totaling $9.2 million were held on the on-balance sheet facility at July 31, 2007, with the related loans and liability reported in assets and liabilities held-for-sale. OOMC was not in compliance with certain restrictive covenants relative to this facility and obtained waivers through September 30, 2007.

Restructuring Charge

During fiscal year 2006, we initiated a restructuring plan to reduce costs within our mortgage operations. Restructuring activities continued during fiscal year 2007, and we expect this will continue until the sale or termination of our mortgage operations is complete. Charges incurred during the current quarter related to an additional restructuring plan announced on May 17, 2007,

totaled $16.1 million, and are included in “other adjustments” in the table below. During August 2007, we announced further reductions in staffing, which will be recorded during our second quarter and are estimated to total approximately $16 million to $20 million. Changes in our restructuring charge liability during the three months ended July 31, 2007 are as follows:

(in 000s)
		Accrual Balance as of				Cash				Other				Accrual Balance as of
		April 30, 2007				Payments				Adjustments				July 31, 2007
Employee severance costs		$	3,688			$	(9,792	)		$	13,424			$	7,320
Contract termination costs			10,919				(1,169	)			2,673				12,423
		$	14,607			$	(10,961	)		$	16,097			$	19,743