H&R Block, Inc. (HRB) Q1 2017 Earnings Report, Transcript and Summary

Good afternoon. My name is Mariana, and I will be your conference operator today. At this time, I would like to welcome everyone to the H&R Block First Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. It is now my pleasure to turn the call over to Colby Brown, Vice President, Investor Relations. You may begin your conference.

Thank you, Mariana. Good afternoon, everyone. And thank you for joining us to discuss our fiscal 2017 first quarter results. On the call today are Bill Cobb, our President and CEO; and Tony Bowen, our CFO. In connection with this call, we have posted today’s press release 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’ve reconciled the comparable GAAP and non-GAAP figures in the schedules attached to our press release. Before we begin our prepared remarks, I will 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 2016 and our other SEC filings. H&R Block undertakes no obligation to publicly update these risk factors or forward-looking statements. At the conclusion of our prepared remarks, we will have a Q&A session. During Q&A, we ask that participants limit themselves to one question with a follow-up, after which they may choose to jump back in the queue. With that, I’ll now turn the call over to Bill.

Thank you, Colby, and good afternoon. Earlier today, we announced results for our fiscal 2017 first quarter, which ended July 31st. As a reminder, given the highly seasonal nature of our business, the first quarter is not indicative of our performance for the full year. To put it in perspective, first quarter results typically represent less than 5% of our annual revenues and less than 15% of our annual expenses. Tony will walk you through the first quarter results in greater detail shortly, but overall they were in line with our expectations. Our financial results varied from the prior year, primarily due to the impact of the divestiture of H&R Block Bank and the increased interest expense due to the issuance of long-term debt last September. With that context on the quarter, I’ll now spend a few minutes providing an update on our preparations for the upcoming tax season. As I shared during our call in June, our focus for tax season 2017 is to arrest the client decline, and I can assure you that the entire Company is laser-focused on achieving this goal. To understand the drivers behind the client loss, we’ve analyzed data from the 2016 tax season. This work confirmed that we maintained relatively stable retention rates year-over-year and that our challenge remained attracting new clients. With greater competition, both from aggressive offers in the industry and an increase in the number of independent tax preparers, our value proposition struggled to resonate with new clients. With a better understanding of the issue, we then evaluated all aspects of the business, products; promotions; pricing; marketing; service delivery; operational processes, everything. We have spent this summer developing a multifaceted plan to appeal to new clients. What we have developed for tax season 2017 will result in an H&R Block that will look very different from what you’ve seen in the past several years. We will be aggressively going after clients in both the assisted and the DIY categories. We will have compelling product offers and an improved client experience that we believe clients will value. And we will make sure the marketing message appropriately communicates that value. Our marketing campaign will be fundamentally different from last year. Also, we’re making progress on our cost reduction efforts, but given the nature of our business, we don’t expect to realize majority of those benefits until later in the fiscal year. And as we discussed in June, we intend to use a substantial portion of the savings to fund our operational objectives for the upcoming tax season. While I look forward to delivering a strong 2017 tax season, we will not sacrifice the long-term health of the business to achieve short term success. Rather, the changes we’re implementing will further strengthen our overall value proposition. We remain a strong Company with a history of delivering for our shareholders and I look forward to continuing this practice going forward. I’m excited about the future of H&R Block and the opportunity to demonstrate strong performance for our clients and for our shareholders. With that, I’ll now turn the call over to Tony to review the quarter’s financial results.

Thanks Bill and good afternoon everyone. As Bill mentioned, the first quarter results represent a small percentage of our annual revenues and expenses, and are not representative of our full year performance. With that as a backdrop, I’d like to provide additional context on the quarter. Revenues decreased $12.5 million to a $125 million, primarily due to the impact of the divestiture of H&R Block Bank. This included the reclassification of mortgage portfolio interest income to other income, the loss of investment income from available for sale securities, and lower Emerald Card revenues, resulting from payments to our third bank partner. Lower U.S. tax return volume and the impact of foreign exchange rate fluctuations and our international businesses also negatively impacted revenues. Turning to expenses, total operating expenses decreased $2 million to $310 million, primarily due to cost reduction efforts which were partially offset by occupancy cost and amortization expense related for franchise acquisitions in the prior year. Not included in operating expenses is interest expense, which increased $13 million from the prior year due to the issuance of long-term debt in September of 2015. Pretax loss increased $16 million to $203.5 million. The increase in pretax loss was driven by the increased interest expense and changes related to the divestiture of the Bank. Excluding these two items, pretax loss would have improved $3 million compared to the prior year. Notwithstanding the changes discussed, EBITDA loss increased just $2.5 million to a $141 million and again was entirely due to the Bank divestiture. Income taxes were less favorable during the quarter due to the discreet tax benefits we recognized during Q1 of the prior year. We continue to expect our full year tax rate to be in the 35% to 36% range. Finally, our loss per share increased $0.20 to $0.55; approximately half of this increase was due to the reduction in share count which will be accretive on a full year basis, but negatively impact those quarters in which we have a net loss. The remainder of the change in loss per share was due to the increase in pretax loss mentioned earlier. Turning to discontinued operations, Sand Canyon’s representation in warranty accrual decreased $40 million from the prior quarter to $26 million as a result of the settlement with the counterparty. The settlement was fully covered by existing accruals. As a reminder, Sand Canyon is and always has been operated as a separate legal entity from H&R Block. We continue to believe our legal position is strong on any potential corporate bell pushing [ph] arguments. Turning to our capital structure, we repurchased an additional 2 million shares during our first quarter at an aggregate price of $48.6 million, bringing total repurchases under the current $3.5 billion authorization to over $2 billion. There are number of factors that impact our share repurchase decisions including our financial position, market conditions, blackout periods and operational considerations. We are committed to returning capital to shareholders through share repurchases, and going forward will continue to be opportunistic at our approach. With that, I will now turn the call back over to Bill for some closing comments.

Thanks Tony. Before we move to Q&A, I’d like to address one other item. Historically, we’ve held an investor conference in the December in conjunction with the release of our second quarter results. Given our stated objectives of arresting the client decline and the work it will take to get there, it’s imperative that the management team stay focused on executing against this goal. Additionally, we will not reveal the majority of changes we are implementing in advance of the tax season given the industry’s competitive environment. Thus, we will not be holding an investor conference this year. That said, we will include guidance on a select number of financial metrics during our second quarter call in December. This is the right decision. It is substantial that we remain focused on flawlessly executing our plan for the upcoming tax season and it also saves us the money, which is always a good thing. With that, we are now ready for questions. Mariana?

[Operator Instructions] Your first question comes from the line of Jeff Silber with BMO Capital Markets. Your line is open.

Thank you so much. I really do understand the competitive nature of your business and your reluctance to give us a little bit more color about some of the changes. But,, is there anything you can tell us at a high level, why this next tax season will look different than the last one?

Well, I think, Jeff, what I’ve said is, we’re going to be more much aggressive on both the assisted and DIY channels in our offers; we’re going to be moving forward with some client experience enhancements. And again, for competitive reasons, I’m not going to go into the details of that, but you’re going to see a very good H&R Block in tax season 2017.

Okay. And just continuing on the same, I know you talked a little bit about the change in the EITC refund policy from next year. I just was wondering, if you’ve had a little bit more time to study that and what impact it might have on your business next year? Thanks.

Do you mean the CapEx?

Yes, please.

So the CapEx, I mean refunds will be delayed on certain credits like EITC and childcare credits until February 15th. We’re still studying that what the impact of that is. Obviously, I think it’ll have a disruptive effect on the tax industry, and we’re going to obviously be looking for initiatives to take advantage of that and support our clients during that timeframe.

All right. I’ll get back in the queue. Thanks so much.

Thanks Jeff.

Your next question comes from Gil Luria with Wedbush Securities. Your line is open.

Good afternoon. Thank you. I wanted to ask, if you could provide us a little more detail on the cost reductions that you’ve taken. Have you quantified how many full time equivalents have been reduced and on what base? You have such a variance in terms of the seasonal account. Have you completed those measures? At this point in time, I understand you’re saying that they won’t really kick in until tax season and then even than a lot of it’s going to be reinvested. But have those been completed at this point?

Hi Gil, thanks for the question. I think your are cutting out a little bit. I think you’re asking about how many positions we reduced as part of the cost reduction that went through about last April. So, we did reduce by about 250 full time positions both at our corporate office as wells in our fields. So, those are essentially behind us. We did do a number of other cost reduction efforts, which you’re seeing farther benefit in Q1, but there was a couple of numbers going against this. We had some amortization, as well as some additional rents that we’re paying on behalf of our franchise buybacks from deals we did last year that now are impacting us in Q1. We also have some payments that we’re making to our bank partner as part of that transaction. So, those are all potentially moving in the wrong direction. And despite that we did reduce our operating expenses about $2 million during Q1. So, the other point to add on though is, there are some of the cost reduction efforts that are going to be more impactful during the tax season. We’re still deciding which of those cost reductions we’re going to be reinvesting in the business. But given the nature of -- 75% of our revenue and a significant amount of our expense comes in Q4, there is going to be a delay to some of our cost reductions.

I think the only thing I’d add to what Tony said, Gil, is that the way the expenses are rolling out, and obviously with the oddity of our highly, highly seasonal business, the expense plan or the actuals in Q1 were in line with our expectations.

Your next question comes from Scott Schneeberger with Oppenheimer. Your line is open.

Thanks, good afternoon. I’m following up on Gil’s question. Tony, you quoted in the press release, expenses are down slightly this quarter, the majority to occur after the first quarter. And Gil framed this question on most of its going to probably come in the tax season. I’m just curious, might we see a bigger improvement in the fiscal second quarter or we wait until tax season, and maybe a little bit more color around those headwinds you outlined in the first quarter, how they might impact second quarter? Thanks.

Yes, I think -- thanks Scott for the question. I think we’re going to see a continuation of some of those headwinds, the rents that we’re now picking up for the buybacks we did last year, franchise buybacks that is, as well as some increased amortization expense as well as just an ongoing payment to our bank partner which, part of that -- and that mainly impacts us more during the first quarter as far as the bank partner relationship because you remember, we closed that transaction during August of last year. So, we’re going to essentially have that year over year variant behind us after we move out of Q1; we still have about a month in Q2 but most of it will be behind us. So, I don’t think you’re going to see a much different story on the cost line in Q2 because we still are going to have the increased rent and a few other things that are essentially headwinds. So, most of that will still impact us during the tax season.

And the other thing is Scott with our business as you know, you’ve covered us - the industry for a number of years, as the IRS wins or when the e-file date is et cetera, January can look a little funky. So, it’s all about our complete fiscal year and seeing how that nets out. We have said that we will have a lower expense line on marketing; where that falls relative to last year, I’m not going to try to manage the Q3 earnings; we’re trying to manage through our full fiscal year. So, that’s why it’s difficult for us to really comment on the quarterly piece except to say that as we have looked at Q1, as we look at Q2 to Tony’s point, then we head into Q3 when things can be more determined by externalities, that’s why it gets difficult on a quarterly basis to really give you a really specific answer.

Okay, thanks. And then for the follow-up, obviously a positive development here for Sand Canyon. Could you guys please elaborate on what that settlement was? And obviously there’s a remaining reserve, so what exists out there and just update on where the tolling agreements are? Thanks.

Scott, this is Tony. Overall, we’re pleased with the progress the Sand Canyon’s team’s made. They did have a positive settlement during the quarter. We don’t speak specific to the counterpart that they did settle with but it was a $40 million settlement, as I mentioned in my opening comments. So, they still have about $26 million remaining under the representation and warranty accrual. That being said, there are some other contingent liabilities that are as you see disclosed in our 10-K, do a good job of outlining what those are. So, I would just refer you to those. We still think this is going to be a measured in a matter of years, not months. It’s going to take some time to wind down. They are making great progress but it’s just one of those things that’s still going to take some time.

And if I could just clarify that, Tony, I was under the impression that there was one large group with which tolling agreements were occurring and that was everybody, and it looks like something just got settled. So, is it kind of piecemeal or bunch of groups or is that we have to check the K or not something you can elaborate on?

Yes. Scotto, we don’t want to talk about specific settlements, unless you’re exactly what you’re referring to. But, it has been great progress, but it’s still going to take some time to wind down.

Your next question comes from Kartik Mehta with Northcoast Research. Your line is open.

Good afternoon. I wanted to get your perspective on what you expect for overall industry growth in terms of tax returns for next year?

Kartik, at this point -- and as we get closer to tax reason, we may refine this. But at this point, we expect the continuation of the trends we’ve seen over the past couple of years. I think we’re anticipating total industry growth between 1% and 2%. It does seem that filing happens later rather than earlier. I think DIY will grow faster than assisted. I think DIY will be in the 4% or so range; assisted in the 0% or 1% increase range. So, I think right now in terms of our planning, we’re anticipating it being in line with the past couple of years.

And Tony, I just wanted to get your thoughts on margins, as we’ve looked to this year, you talked about cost cuts; you’ve talked about being aggressive just going after clients. I am wondering, how does that translate to EBITDA margins for this year and I guess either growth or contraction?

Kartik, so, we’re going to share more information on our Q2 call as Bill mentioned, so we’re not going to talk specific about it. At this time, we’re still sticking to our long-term guidance of 28% to 32% for EBITDA margin, but we’re going to share more information on our Q2 call.

Your next question comes from Michael Millman with Millman Research Associates. Your line is open.

Thank you. When we look out I guess first half of the tax season, second half of the tax season, should we be looking for the Company to decelerate their declines or in fact be able to put up some increases in one of those periods? And so, related to that, is there a focus more on volume or more on revenues? Thank you.

Yes. I will start off Michael and then Bill can add on. I would say, our main focus is on arresting the decline. Obviously growth is the ultimate goal. But coming off the year, we just had in both the assisted and the DIY channel, our main kind of step one, if you will, is arresting the decline. Obviously we’re hoping for growth but not necessarily targeting that at this point. So, that’s -- and what was your second question, Michael?

And so, just on that, would that be true for both the first half where you do have a lot of new tax payers and the second half as well and you have existing, more existing? So, maybe just go there and get back to the second half -- the second question.

Yes, with regard to the first half, second half, I don’t think we are in a position yet to comment on the split or where that will land. I think Tony laid it out well that the goal here, we can’t afford to have another year where we’re down almost a million clients. So, job one is to arrest to the decline and that’s where our focus is.

So, that may answer the second question, which was is the focus more on volumes than on revenues?

I think sometimes that said an artificial construct but clearly we have to be focused on the client numbers. So, I’m not going to comment more specifically than that but just said our primary focus is to arrest the client decline.

[Operator Instructions] And your next question comes from George Tong with Piper Jaffray. Your line is open.

Hi. This is Adrian Paz on for George Tong. Given the industry’s increasing use of RIA like products, what is your position on offering particularly [ph] RAL products? And if you could perhaps provide some color on where you are in discussions with the potential bank partners?

I’m not sure I heard the second part…

I just want to see if you were having discussions with potential bank partners on offering the RAL like products.

Okay. So, now I understand. So obviously, with the expansion in RALs that were offered last tax season, our estimates are that they’re over 1 million of them offered, primarily through the independent channels. So, we’ve certainly taken a look at that. We’re continuing to look at that. Whether we will have one or not, it’s certainly something that we are not ready to comment on this year. We would be in a position where we would always partner on this. I’m not going to say what we’ve done with regard to any discussions with partners but as I’ve said, in terms of having an aggressive tax season, in our mind everything is on the table and at the appropriate time we will reveal what our plans are.

And just one more, now having reflect on the 2016 tax season, can you discuss how your thoughts have evolved on the ACA impact and why it can really materialize in 2016 and what your thoughts for 2017 for the ACA?

Yes. As I said on the Q4 call, I mean, we are surprised that the impact was not growing in tax season 2015; every indicator was that it would be but it didn’t happen. The number of people in exchanges again this year has gone up. The IRS now has all the 1095 forms that everyone had to file last year. So, everything is set up for increase in terms of the impact on the tax season. But, we’ll just have to wait and see. I still believe that over time, this will be a net benefit to a company like H&R Block but hard to say what it will be in 2017, given that we are surprised. But all the indicators would show that the impact will be higher in 2017.

There are no further questions at this time. I will turn the call back over to the presenters.

All right. Thanks Mariana and thanks everyone for joining us on today’s call. Have a great day. Thank you.

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