H&R Block, Inc. (HRB) Q1 2014 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the fiscal 2013 First Quarter Earnings Conference Call. My name is Adrian, and I will be facilitating the audio portion of today's interactive broadcast. [Operator Instructions] At this time, I would like to turn the show over to Mr. Colby Brown, Vice President of Investor Relations.

Thank you, Adrian. Good afternoon, everyone, and thank you for joining us to discuss our first quarter fiscal 2014 results. Joining me on the call today are Bill Cobb, our President and CEO; and Greg Macfarlane, our CFO. Other members of our senior management team will be available during the Q&A session. In connection with the call, we have posted today's press release and slide presentation on the Investor Relations website at hrblock.com. Some of the figures that we'll discuss today are presented on a non-GAAP basis. We reconciled the comparable GAAP and non-GAAP figures and the schedules attached to our press release and in the Appendix of today's slide presentation. Before we begin our prepared remarks, I'd like to remind everyone that this call will include forward-looking statements as defined under the securities laws. Such statements are based on current information and management's expectations as of this date and are not guarantees of future performance. Forward-looking statements involve certain risks, uncertainties and assumptions that are difficult to predict. As a result, our actual outcomes and results could differ materially. You can learn more about these risks in our Form 10-K for fiscal 2013 and our other SEC filings. H&R Block undertakes no obligation to publicly update these risk factors or forward-looking statements. With that, I'll now turn the call over to Bill.

Thanks, Colby, and good afternoon. I hope everybody had a great Labor Day weekend. Earlier today, we announced our first quarter results for fiscal year 2014, which ended July 31. As many of you know, our off-season results are not indicative of our financial performance for the full year given the seasonality of our business. Greg will take you through the details of our first quarter earnings later in the call. We have been hard at work this summer in planning for the upcoming tax season and beyond, and I'm very pleased with the progress we've made. We have a lot of work to do, but I'm confident that we're poised to take advantage of the long-term opportunities that lie ahead. We'll have much more to say about this during our Investor conference in December, but I'll offer a few insights today regarding the upcoming tax season, H&R Block Bank and our efforts regarding health care reform. First, while we don't have complete information from the IRS on returns filed on 2013, we've already begun to leverage some of the lessons learned from last year. We continue to believe that many of the challenges faced by the industry last season were an exception, and we now expect IRS filings to grow around 1% in 2014. Looking ahead to this season, we have to focus on what we do best, serving our clients the way they want to be served. Our primary objective will be consistent with last year, striking the right balance of profitability and growth. Next I'd like to talk about H&R Block Bank. Last year, we announced that we're exploring strategic alternatives for our bank due to proposed rules that would impose higher capital requirements on savings and loan holding companies. The regulatory constraints that would result from these proposed rules are inconsistent with our strategic plans. Thus, our aim was to exit the bank with the hope of accomplishing 2 primary objectives. One, to cease being regulated as a savings and loan holding company; and two, to find the right partner to help us continue to grow our financial services business. We have been diligent in our pursuit of these 2 objectives, and in July, we announced that H&R Block Bank had entered into a definitive agreement with Republic Bank & Trust Company to sell certain assets and liabilities, with the intent of forming a long-term relationship with Republic to offer financial services products to our clients. We're confident that the structure we put in place and the partner we selected accomplished our 2 objectives. As discussed on our call in July, the transaction was contingent on various closing conditions, including successfully negotiating, executing and fulfilling other agreements with Republic, and receiving the required approvals from each party's respective regulators. Prior to entering into this agreement, Republic, which currently operates under a state bank charter, filed an application with their regular -- regulator to convert to a national bank charter. This application is being processed by Republic's regulators concurrent with the review of the transaction between H&R Block Bank and Republic. At the time of our announcement, we were hopeful, based on our review of recent bank transactions of the approvals, would take 2 to 3 months. We acknowledge, however, that it was difficult to know with any certainty how long the process may take, and as such, that there was a possibility that regulatory approvals may not be received as soon as we had hoped. Republic has indicated to us that their regulators will require additional time to process their applications. Though both parties have done everything in their control to finalize the transaction and have made significant progress in negotiating the remaining required agreements, this development makes it unlikely that regulatory approval will be received by September 30. As a reminder, September 30 is the deadline for regulatory approval as stated in the agreement to enable the transition of the company's financial services products to Republic in time for tax season 2014. Thus, we expect to continue offering our financial services products to our clients through H&R Block Bank for the upcoming tax season. Though we are disappointed in this development, we are prepared for it. Our bank remains well-capitalized and we've made significant progress in our financial services business over the last few years. In particular, we are pleased that Emerald Card continues to rank as one of the top amongst its competition in independent reviews of the prepaid debit card market in the U.S. This is a testament to the value our financial services products bring to our clients everyday. I'm confident that we will continue to provide consistent, best-in-class services and products to our clients this upcoming tax season. That said, I want to be very clear. We remain focused on exiting the bank and continue to believe it is the best -- it is in the best interest of our company and our shareholders to do so. Exiting the bank allows us to cease being regulated as a savings and loan holding company and allows greater flexibility with our capital structure strategy and our ability to return capital to shareholders. Now many of you have asked specifically about share repurchases. We have made requests to our regulator to repurchase shares over the last 12 months. However, we have not received approval to do so. Now turning to health care. Activity has picked up regarding the Affordable Care Act, or ACA, with the health insurance exchanges opening October 1. We expect that there will be increased publicity in the coming months as Americans begin to think about their health insurance options and how their tax situation is impacted by the requirements under the new law. We continue to believe that health care reform will not result in a materially positive impact to our business in fiscal year 2014. And while we haven't received any additional updates on what new forms the IRS may employ or how some aspects of the law will be implemented, we believe Americans will need help, and that H&R Block Bank -- H&R Block is best suited to assist them in this process. Last quarter, we talked about a nationwide program for health care exchange enrollment, as well as a pilot program that we will be running in 1 state. I'm pleased to announce that we have contracted with GoHealth, a company with extensive experience in the insurance industry, to help us execute these plans. Throughout the nation, we've joined with GoHealth to provide an H&R Block branded service that allows our clients the option of purchasing their health care insurance online or over the phone through licensed GoHealth agents. Additionally, our pilot program, which we will run in Arizona, will allow clients to be served in our offices with licensed agents on-site. These agents will help our clients understand what the new law means for them and their tax situation and will assist clients in selecting and enrolling in health insurance. In addition to our relationship with GoHealth, we again plan to place an emphasis on our tax and health care review in all of our offices across the country this tax season. Last year, our clients appreciated the value provided by this review, and we believe it will be even more relevant this year due to the continuing implementation of the Affordable Care Act. While it's likely going to take a few years for any opportunity presented by health care reform to develop, we have to make smart investments now to ensure we're prepared to serve our clients and meet their needs in the space. Rolling out these initiatives will likely be dilutive to earnings by approximately $0.03 to $0.04 per share in fiscal 2014. As I've said, this is a long-term play, and we'll need to be prepared when our clients turn to us for help in understanding how the new law impacts them. With our size, scale and resources, we are well positioned to serve our clients, and I believe offer a compelling and unmatched value as American seeks assistance. Our investment today will allow us to stay ahead of the competition and ensures that we are the trusted brand for Americans as they seek to understand this newly created intersection of taxes and health care. We'll provide further details regarding our efforts in this space during our Investor conference in December. With that, I'll now turn the call over to Greg to discuss the first quarter financial results.

Thanks, Bill, and good afternoon, everybody. Earlier today, we reported our adjusted net loss from continuing operations increased 3% to $108 million or $0.40 per share. These amounts exclude nonrecurring bank transaction costs in the first quarter of approximately $8 million or $0.02 per share. GAAP net loss per share from continuing operations of $0.42 was $0.04 higher than in the previous year as increases in revenues were more than offset by an overall increase in expenses. The variance is primarily driven by increases in expenses related to the bank transaction, higher variable costs on increased revenues, foreign exchange adjustments and increased legal expenses. Turning to our tax -- our segment results, Tax Services revenues increased $31 million to $122 million, primarily driven by an increase in revenues in our international operations of $21 million. This was due to timing differences in our Australian operation as revenues shifted from the second quarter to the first quarter. Additionally, fees for financial services increased this quarter as preliminary results indicate that Emerald Card usage is improving in the offseason. The increased revenue was more than offset by an increase in operating expenses, which grew $35 million to $266 million. This increase is due to greater variable costs on higher revenues and the foreign exchange currency losses and higher legal fees mentioned earlier. This resulted in a $3 million increase in the segment's pretax loss to $144 million. In corporate, revenues declined slightly due to lower interest income from H&R Block Bank's diminishing mortgage loan portfolio. Operating expenses increased $11 million to $46 million, primarily due to professional fees related to the H&R Block Bank transaction, partially offset by lower interest expense. Accordingly, our pretax loss increased to $12 million to $40 million. As we look at our overall financial position, our balance sheet and liquidity remains strong. As of July 31, total unrestricted cash was $1.2 billion and total outstanding debt was $907 million. Reductions in cash from the prior quarter reflect our normal offseason operating cash requirements. Our first quarter effective tax rate of 38.6% was up 100 basis points to the prior year, driven by differences in discrete tax items. We continue to focus on lowering our effective tax rate. But due to the significant one-time tax benefit received last year, we'd expect our effective tax rate in 2014 to more closely approximate pre-2013 levels. Turning to discontinued operations, which include results of Sand Canyon. Our first quarter net loss of $2 million was essentially flat to the prior year. During the first quarter, new representation of warranty-related claims at Sand Canyon were $69 million. Sand Canyon completed a review of claims during the quarter with an approximate principal balance of $39 million with no losses paid. At quarter end, total claims of $72 million remain subject to review. Sand Canyon continues to engage in settlement discussion with the counterparties that represent a significant majority of claims submitted to date. Sand Canyon's accrual for contingent losses, relating to reps and warranties, remains unchanged at $159 million. Before I turn it over to Bill, I want to thank all of you who took time to meet with us during our roadshows earlier this summer. It was helpful to hear your perspective, and I look forward to continuing our dialogue at this year's Investor conference in New York City. I'll now turn the call back to Bill for our closing remarks.

Thanks, Greg. In conclusion, I am pleased with the progress we've made this offseason in preparation for tax season 2014. This year, we'll continue to focus on driving profitable growth and maximizing our value offering to our clients. There, obviously, remains much to do. But as we look ahead, I like our competitive position and believe that we have the right people, resources and expertise to continue to provide best-in-class service to our clients. When I took this job more than 2 years ago, I told you that I joined this company because I believe not only in our brand, but in the long-term opportunities of the business. I believe in these opportunities now more than ever and feel the actions we've taken in the past few years, position us well to capitalize on them in the years ahead. We look forward to sharing additional plans with you at our Investor conference on December 11 in New York City. With that, we're now ready for questions. Operator?

[Operator Instructions] Your first question comes from the line of Kartik Mehta from Northcoast Research.

I think initially when you talked about the bank sale, you had indicated that you thought it was going to be $0.06 to $0.09 dilutive. And as you look at the fact that it's been delayed, would that mean that it won't be at least that dilutive for the upcoming fiscal year? Or have things changed? Or are there other expenses maybe that you aren't thinking about that have to be considered now?

Kartik, it's Greg. Earlier this summer, when we made the announcement about the signing of purchase assumption agreements that were filed with the various regulators. We had also shared our thoughts on what the financial implications of the transaction would be. And so you're correct in that we have said that we would expect $0.06 to $0.09 per share in fiscal year 2014, and we also indicated that there be an additional $0.03 to $0.04 of one-time charges that we'd incur. Given the regulatory delay and our belief that tax season '14 will be processed H&R Block Bank, the $0.06 to $0.09 will not be -- will not impact us this year. However, the one-time cost, $0.03 to $0.04, we still estimate will impact us. In fact, in the first quarter that we just reported, you already saw $0.02 of that included in those numbers.

And then I think, Bill, you talked you had gone to regulators to try to buyback shares. Obviously, they've said no. Maybe a 2-part question here, can you talk about maybe the amount of authorization you were requesting and maybe what their hesitation was, if they told you?

So no and no, the answers to the question, but I'll elaborate a little bit. No, I'm not going to discuss conversations we have with our regulator. I don't think that's appropriate. So I'm not going to talk about that. And obviously, with regard to -- there are very specific capital holding requirements that have been published. And we are obviously fully mindful of those. But Greg, I don't know if you want to add anything, but we're not going to discuss amounts.

Our team continues to be the same that we're working hard to sell the bank. And there's 2 reasons we're selling the bank is first and foremost, we're looking to find a great solutions for our clients, and we're excited about the opportunity to sit there. And so we need to find a partner that will continue to support that, which we have in Republic. And the second goal is to cease being regulated as a savings and holding company and this is really tied up in the capital requirements that were part of the Basel III legislation that was passed.

And then just one final question, Bill or Greg, any change in strategy on the bank products now, especially with you controlling them this year, thoughts about if this year will be different now versus if when Republic was going to take control of them?

No, there's no change in strategy. The same products that we've offered in the past will continue to be offered. And that was the same whether we're able to have received regulatory approval, or as we indicated now, we are likely to use the H&R Block Bank. So the products -- remember, these H&R Block branded products, whether it was Republic or H&R Block Bank, these are the products -- it's about the client facing products and we always wanted to make this seamless, so there is no change in strategy.

Your next question comes from the line of Thomas Allen from Morgan Stanley.

You mentioned in your prepared remarks that Emerald Card usage was improving. Can you just give us any kind of additional metrics or color you can on that?

So we're very excited about the Emerald Card. Last December at our Investor Meeting, we shared with you a lot of the features and functions that we've been beefing up. We had a tax season where we sold a lot of those cards. We continue to believe that selling more cards is an opportunity, but the real magic, the financial magic for H&R Block is convincing clients that, that card, that Emerald Card product, is fully functioning and can be used as a year-round debit card solution. And I think early results are positive, Thomas, but truthfully I think that we still have long room for improvement to get to what we sort of expect entitlement to be and this will be one that we will talk about more in December. But we don't have any specific metrics that I would want to share with you right now.

Okay. And then any updated thoughts around your dividend? Do you look at it on a payout ratio basis or yield or what? And kind of are you being restricted on increasing your dividend to? Or is that kind of different?

So we, I guess, just declared again our quarterly dividend, so that's good news. As I said, as we've said before, we don't talk about specific discussions with the regulators. What we shared with you today is specific commentary we felt appropriate around share repurchases. But I'm not prepared to talk about dividends at this point.

But obviously, we've been able to continue the dividend throughout this time and plan to continue to do so.

Okay. And just final one, why did you choose Arizona for the navigator program for the pilot?

Yes, I mean, there's a variety of reasons. There's internal reasons about execution, et cetera. But overall, we like the market characteristics, the demographic characteristics. We felt it was going to be a good pilot for us and a good place to do that. And it was a variety of factors, but we're excited about the team we've put in place down there and we're ready to go on October 1.

Your next question comes from the line of Scott Schneeberger from Oppenheimer. Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: I guess, first, probably not surprising that there's a delay, it was a pretty tight window on getting regulatory approval. I guess the key question I have, Bill, is will it be -- how comfortable are you with Republic, again not shocking on the delay, but do you feel comfortable they will be approved as your counterparty by, I think, March 1 is the next regulatory deadline? And has this increased your uncertainty? Or is it just the delay you might look elsewhere for another party?

I can give you the official legal, you can never count on regulators, but let me answer in a different way. Obviously, that is true but I feel that we still believe we have chosen the right partner. We still believe that approval will be forthcoming. We have had a very good partnership with Republic, as we've said in our remarks, we've made substantial progress in all the various agreements. And I think we've had good open dialogue with all the regulators. So there's no reason for us to feel, at this point, that this is anything other than the way you described it. Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: Okay, fair enough. You mentioned at the beginning, and I just want to clarify it. And then ask a subsequent question, was it IRS growth returns that the IRS growing 1% for the fiscal '14 year?

So that is our best thinking as we sit today that we think that the year was an anomaly. The hard part is we still haven't received final numbers from the IRS for 2013. And I think other tax preparers have said this, it's a little difficult to analyze. But in terms of our current thinking, we're thinking that IRS filing growth for 2014, at this point, will be around 1%. In December, not to assume that there will be any change, but obviously we'll update those assumptions when we meet with you in New York. Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: And a follow-up to that is how do you anticipate your performance, perhaps your revenue growth or your returns growth response, I guess, revenue would be the more desirable answer relative to IRS.

Yes. I think we're going to -- we're still heavily into the planning season. So I don't have anything to share with you on that. Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: Okay. And then I guess, Greg, could you speak a little bit the higher legal fees within tax and then you mentioned -- and you might have broken this down, I just didn't get a chance to work it out, the sub-segmentation, the higher variable cost on the increased revenue in the Tax Services segment year-over-year. Is it -- could you piece that out a little bit more? I think you may have covered it, but just to be clear, because I thought with all the cost savings initiatives, you would have been down a lot. Just curious about the variable part and was it really the legal fees that drove it higher? What were the associated legal fees? And then I'm sorry, the long question with a few parts. But lastly, any feel for the incremental ability to have cost savings beyond the $15 million that trickled through that you had outlined for fiscal '14?

That's okay. So in the first quarter and you'll have a chance to digest this when you get the quarterly filing here and also we'll be happy to talk through more specifically. But in general, I kind of looked at the first quarter expense numbers and see a lot of noisy things in there. The noise includes legal fees, as I mentioned, there was a foreign exchange mark-to-market that went through, the bank sale related fees of $0.02 a share, we had a timing difference with Australia, which pulled forward both revenue and expenses. But I'll first talk about expenses, you'll see increased expenses because of that. When you isolate each of those items, they're kind of smaller in the grand scheme of things. You kind of get a more normal run rate, and I'm pretty satisfied that the first quarter run rate is very much in line with what I was expecting coming out of a -- the cost work that we have done in fiscal year 2013. I think the broader maybe question you're getting at is how do we sort of see expenses shaping up for the year. Last year, we guided to about -- we said, we want to be in the 27% to 32% EBITDA margin range. Last year, we moved to 30%. And I think right now my best estimates will be in around 30% this year. Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: That's helpful and that kind of -- a broad way to answer all the questions. I guess, the last one I had to follow on that, though, which we may have just covered it, this incremental $0.03 to $0.04 dilutive impact from your ACA initiative investment upfront, that is included in everything you just said, the 30% margin this year and any incremental cost reduction?

It would be included in the 30%, plus or minus number, I just mentioned, Scott.

Your next question comes from the line of Gil Luria from Wedbush Securities.

Would you mind elaborating a little bit on the GoHealth relationship? Is this something that would be available through your website? Or is there an aspect of it that you'll start incorporating into the store this year? Could that be a potential source of revenue this year? Or does that fall under the expectation for a revenue impact only further down the road?

Yes, Gil, let me handle that last part of your question. I mean, our belief is, as Greg indicated -- or I guess I indicated in my remarks, the $0.03 to $0.04 includes, I believe, that revenue off any of our initiatives for this year will be immaterial. Obviously, we've got pilots in place, so it's primarily an expense-driven area as we go forward in this. But we think, as I stated, it's important that we get into this issue, I think that there is an intersection here of taxes and health care. I think we are the best position. So we are going to launch our efforts in 2014. What I'd like to do specific to GoHealth is Jason Houseworth is with us in addition to, as I tell him, his day job running our digital business. He is also leading our initiative in health care, and he's worked very closely with the team with GoHealth. So why don't you describe a little bit about what they're doing, Jason?

Sure. Thanks, Bill. So Gil, to answer your question, both will really be available to clients. They will be either available to go into the website for both an enrollment and plan selection, as well as in the state of Arizona, have licensed and appointed health pros or think about it as a tax pro to help clients enroll and select a health care plan. And GoHealth is just the underlying platform that will service both of those channels. However, to the client, the client will really see an HR Block-branded health service when it comes to enrollment and plan selection.

Got it. So you will not be rolling out the platform into your stores outside of Arizona?

So just to be clear, the platform will be available on a 50 state -- I mean, it's going to be online and there will be a number through the telephone. So any one can access GoHealth. But in terms of us having insurance agents/brokers in all of our offices, that will only be in Arizona. Is there anything you want to add, Jason?

No. Good clarification. Thanks, Bill.

And then I want to ask the share buyback question a little differently. Obviously, I don't want to share the specific conversations you're having with regulators. But is it safe to assume that since there's not likely to be a change in status until after this upcoming tax season that your share buybacks will be limited all the way through April 30, 2014, and we should think of it that way?

So what I'll say is that as any regulated entity needs to, we'll have to get permission from the regulator before they do any type of capital distribution. That includes regular dividends, increasing the dividends, share repurchases. We just disclosed to you that we have had made requests for share repurchases, which have not been approved in the last year. Going forward, we also want to make sure that we're not going to give-- to us, our view is we're trying to manage for our shareholders benefits and we don't want to exactly tell our clients because it's very much time-based and situational. So I don't really have a forward-looking kind of view of that for you.

And that's been consistent. We don't forecast or announce share repurchases or dividends in advance. So that's consistent with that. We thought it was important though to -- we're asked about this question in a lot of different ways that we fill you on our broad discussion that we've had with our regulator.

Your final question comes from the line of Michael Millman from Millman Research.

Several questions. One, just following up again on the same topic, do you intend to continue to talk to your regulator regarding distributions and share repurchases?

Well, I think -- again, I'm not going to discuss anything going forward. But we speak to our regulator often on a variety of topics.

So following up on another on your IRS outlook, could you break that down into what you expect total returns, digital and online growth, these 3?

Yes. I think what I'd say about that, Mike, at this point without having full knowledge, we wanted to give you kind of our thinking that's guiding us as we are doing our planning. What I'd say about that is we believe that the assisted returns will be modestly below the 1% and that the do-it-yourself returns will be modestly above the 1%.

Okay. Skipping to something you haven't discussed is DOMA. The IRS has come out and allowed amendments. Can you talk about your thinking on how you're going to present this? I know liberty tax has come out and said they will do these amendments at no cost.

Yes. So we're -- obviously, the information just arrived. We are going through that, working on as we do with anything that comes out as a regulation change, how we'll adapt to that? Obviously, we've always had in place, so it's very natural for us to offer a free second look. We encourage anyone who this regulation might affect, come see us and we'll do that free second look. So we will plan on doing this just as we had for any of our taxpayers with their particular situation as we go forward. So it fits very well in our overall branding and executional efforts to be able to do a second look. So the same will apply in this case.

The look is free, but is there any changes, is that charged for or is that included free?

Yes, I'm not going to talk about pricing specifically.

Okay. Can you maybe discuss this in a way, capital expenditures like they doubled in the quarter, can you talk about what's behind that?

I can. So we believe and we talked last year with all the investors and interested parties that we think more longer-term about 3% of revenues is a good CapEx target. That's obviously, plus or minus. But that feels to be about the right number to refresh our stores, the client experience in the store, the hardware, the software investments that we needed to make to support our business and some other things. Last year, we were higher than that and that's really a reflection of several years where previous management, I think we had under invested in some of those things. And we believe this year also that we'll be spending more than that 3%, again, making up for some lost years there. But I think longer term, we still think that 3% of revenues is the right target for us. Specific to the timing of the quarter, just to add is timing, Mike. I don't -- I think there's nothing unusual in the first quarter to point out to you.

And SG&A was up close to 30%. You've touched upon it, but I wasn't sure if you basically talked to it.

Yes, well, I mean I'll kind of circle back the question from before a little bit because the route is each individual item isn't worth talking about, except in the aggregate. But you have some increased legal fees, our mark-to-market and foreign exchange, bank fees are related to the transaction of $0.02 a share, that was a bit more material. We had a timing difference with Australia as we pulled forward some stuff, that's really just an accounting timing difference in our view. Once you remove all of that, we felt that SG&A was in line with our expectations around what our run rate should have been, coming out of the year when we took a bunch of costs out of that group of expenses.

There are no further questions. I'll turn the call back over to the presenters.

Okay. Thank you, everyone, for joining us on the call. We look forward to talking to you in the future.

Goodbye.

This concludes today's conference call. You may now disconnect.