On first blush, H&R Block (NYSE:HRB) should have a great business. They are a well-known name in tax preparation, and taxes are not only inevitable but increasingly complex. With about 12,000 offices spread across the country and a credible at-home product offering, this should be a great business.

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Unfortunately, things are just not that simple. Intuit (Nasdaq:INTU) continues to grab share in the do-it-yourself market, as have other free (or very low-priced) online offerings. If that wasn't enough, a change to IRS policies has thrown a sizable monkey wrench into the lucrative refund anticipation loan business. Put together, those have put H&R Block, as well as rival preparer Jackson Hewitt (NYSE:JTX) under pressure. Making matters worse, H&R Block's past attempts to diversify beyond tax preparation not only failed, but could still manage to come back and haunt the company a little longer.

An Okay Quarter, But Who Cares?
H&R Block reported a stable fiscal second quarter, but it was not all that significant. H&R Block runs one of the relatively few highly-seasonal businesses still left, and the fiscal second quarter is not part of the busy season. Nevertheless, revenue fell about 1% from last year, while the company's operating loss improved by about $35 million (to a loss of $179 million), mostly on lower SG&A expenses.

Some New Strategies For The Near-Term
Although the financial results of the quarter are not important, the company did talk at length about some considerably more important matters - namely, the company's near-term strategy for tax season, its plans for refund anticipation loans and the potential fallout of its failed mortgage business.

On the tax front, the company plans four significant initiatives for the tax season. The company will process 1040EZ returns for free (hoping no doubt to bring in traffic that may convert to more expensive service offerings) and will also roll out a clearer pricing structure. Management also hopes to capture more early filers with an aggressive marketing push, while also trying to direct more business to its most productive employees (no doubt "productive" is meant to include "good at up-selling").

Those policies all make sense, and the acquisition of TaxACT (for which the company paid about $288 million in cash) should help expand the company's online/do-it-yourself business - an area that is not only profitable, but highly scalable and necessary to stem customer defections to the likes of Inuit.

Hashing It Out With Their Bank Partner
When the IRS decided to no longer provide certain information to tax preparers like H&R Block and Jackson Hewitt that was used in making refund anticipation loans, it really stirred the pot in this highly profitable niche. Although these loans have come under a great deal of criticism and scrutiny (many watchdogs have compared them to payday lending), they are legal, some customers want them and H&R Block has made a lot of money offering them.

The company is still trying to negotiate some sort of compromise with HSBC (NYSE:HBC) that will keep them on board as a lending provider (Jackson Hewitt has likewise had to find compromises with its bank, Republic Bank. In a worst-case scenario, H&R Block could turn to refund anticipation checks, but these are considerably less profitable for the company and they could lose customers to those providers still willing and able to offer the loans.

The Ghost Of Mortgages Past
One of the scarier parts to the H&R Block story is the specter of mortgage put-backs. While HRB got out of this business a while back, some of the buyers of the company's loans have filed claims attempting to compel them to buy back the loans. Although the level of new claims was just $21 million this quarter, and the company is only liable if had knowledge of fraud at the time of origination, this is still an open-ended risk in a market that is badly spooked by anything pertaining to bad mortgages. (For more on the mortgage problems, see The Story Behind The Foreclosure Crisis.)

The Bottom Line
H&R Block has a lot of appealing traits to certain value investors. Although the balance sheet is not pristine, it is manageable and the company has a profitable recurrent business. Moreover, low valuation (enterprise value to revenue of 1.1) and a high short interest (13%) suggest a lot of bad news is already expected. What H&R Block needs, though, is proof that it can rebuild its moat. Online providers of tax advice have whittled away at least some of the company's competitive advantage and shareholders can ill-afford another botched diversification attempt like the mortgage business.

Still, the current price of this stock suggests a slow withering of performance and gives management no credit for being able to sustain (or grow, either organically or through diversification) the business. On the other hand, losing refund loans entirely would probably downside of 20% or so from here, and any significant success by mortgage put-back claimants would likewise be a threat to the stock.

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