H&R Block, Inc. (HRB) Q4 2013 Earnings Report, Transcript and Summary

Good evening. My name is Keisha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Colby Brown. Sir, you may begin.

Thank you, Keisha. Good afternoon, everyone, and thank you for joining us to discuss our fiscal 2013 results. As many of you know, I transitioned into the Investor Relation role last quarter and have enjoyed getting to know many of you. I look forward to working with you over the coming months. 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 this call, we have posted today's press release and slide presentation on the Investor Relations website at www.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 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 2012 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, everyone. Earlier today, we announced our results for fiscal year 2013, which ended April 30. As many of you know, this was a challenging season for the industry as a whole, and while we're continuing to analyze some of the details, there are 3 important takeaways from the season. First, the challenges faced by the U.S. tax industry this year were unprecedented, resulting from late tax legislation, filing delays and an overall decrease in returns filed with the IRS. I'm proud that as an organization, we showed a tremendous ability to adapt to this unique environment and to execute on our plans in the U.S. Globally, I'm pleased that we again served more than 25 million clients worldwide. As the leader in the tax industry for over 58 years, H&R Block has become the largest tax preparer in the world, and our unmatched presence and expertise gives us an advantage as we look to 2014 and beyond. Second, although we executed well on many of our initiatives this tax season, we have room for improvement. Difficult decisions were made this tax season, with a focus on growing the business profitably. And we delivered better financial results in fiscal 2013, achieving our margin expansion goals. I'm also pleased that we grew and took share from Intuit for the third consecutive year in the digital online category, which is the largest and fastest-growing category for do-it-yourself filers. And finally, though there's still plenty of work ahead, we remain confident in our long-term strategy to be a global year-round tax-plus company. We continue to see growth opportunities in digital, financial services and international. And while some of these opportunities may take a few years to develop, I am optimistic about our ability to expand our business profitably and…

Thanks, Bill, and good afternoon, everyone. From a financial perspective, considering the challenges that we faced this year, I believe we executed well and pleased that we continue to drive our strategy. Importantly, we exceeded our goals related to our cost-reduction initiatives, which contributed to significant earnings and margin expansion in fiscal 2013. For the year, pretax earnings increased $126 million to $702 million. A large part of this was driven by exceeding our targeted cost-reduction initiatives, which contributed to a $118 million decline in total expenses compared to last year. The savings are primarily driven by lower compensation and occupancy expenses. Our net income from continuing operations was up $119 million to $465 million. When considering these results together with share repurchases that occurred during fiscal 2013, we increased earnings per share from continuing operations 46% to $1.69. On an adjusted non-GAAP basis, earnings per share from continuing operations increased 25% to $1.59. These non-GAAP results exclude after-tax adjustments of $28 million, or $0.10 per share, primarily related to a tax benefit received in the third quarter from settling outstanding issues in previously filed corporate tax returns. EBITDA of $874 million resulted in an increase in our EBITDA margin of 4 full points to 30%. Total revenues increased modestly to just over $2.9 billion. While we would like to see better top line results in a normal year, I'm pleased, overall, that we remain disciplined and focused, achieving solid earnings growth. In our Tax Services segment, revenues increased $16 million, or about 0.5%, due to these actions taken this year in line with our strategic focus to improve overall profitability. Specifically, higher RAC and digital revenues were partially offset by lower Assisted tax prep-up [ph] fees. The segment's pretax income of $821 million compares to a pretax income of…

Thanks, Greg. As we look ahead, our strategy remains focused on being a global, year-round, tax-plus company. And our #1 purpose for this company is to look at our clients' lives through tax and find ways to help. One of the ways we are well positioned to help taxpayers is in their understanding of how health care reform will impact their lives. As many of you know, the Affordable Care Act mandates that all Americans obtain health insurance in 2014 or pay a penalty through their 2014 tax return. For those electing to receive subsidized coverage when the state and federally-operated insurance exchanges open in October, one is the easiest ways for them to verify their income during the enrollment process is by using their 2012 tax return. Those who receive subsidies will have a mandatory filing requirement in 2015 to report income earned during the calendar year 2014. And we've performed a lot of analysis in this area, and our research suggests that Americans need help in understanding how the new law will impact their lives, their personal finances and their tax returns. We know that many are simply unaware of the resulting complexity that lies ahead. Our job is to understand the law as it is written and help our clients comply with these new requirements as it relates to their tax return. We have not taken nor will we take any position on the law. We just want to help those who are impacted by it. And our clients are among those most heavily impacted by -- affected by the new law, low-to-middle income Americans for whom the tax return represents one of the most significant financial events each year. Based on information we've gathered, we estimate that a greater proportion of our clients will be eligible…

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

A question for you on the pricing side of things. You said you achieved 1.7% pricing. Are you able to give us a little more breakdown on how much of that came from the franchise side and how much of it came from the corporate side?

No, I won't give you a breakdown. I would say it was similar, but I'm not going to go into the breakdown. I think it's better for us to really focus on the system average. A lot of this is due to mix. Our franchisees are primarily in more rural locations, so there are differences in pricing in terms of the amount. But I would look at it more as here's what the system did. Because a number of our franchisees do follow our lead on the pricing front, so I think the system number is sufficient.

Okay. So were your franchisees able to -- are you able to say, Bill, were the franchisees able to get a price increase?

Yes, I can say that.

Okay. And then you talked a little bit about the do-it-yourself tool on the health care side. Is there a revenue opportunity here for you, Bill, or is this some more about client retention, at least as you look at it today?

Yes, I think -- Kartik, let me say this. We obviously are doing this because we think there's going to be ultimately a business impact. I don't know at this point. But certainly, we're going to look at this as a commercial effort, whether that would be in the first year, how that would play itself out. As we get closer down the road, we'll probably have more to share with you on that. But clearly, I think as we would make an investment in that platform, we will be looking to monetize that at some point. But like I said, I don't want to go into it right now and, frankly, I don't know at this point as we make our plans, and as I stated, as we find out how this whole thing unfolds, how exactly that plays out.

And then just one last question, Greg. You look at the cost savings this year obviously did better than expectation. How much of those cost savings will spill into FY '14? I'm assuming some of those, you've gotten halfway through the year. So just trying to figure out how much of that we should look for in FY '14 as well.

About $15 million is a number that we've communicated to you before, and I feel comfortable that, that will flow into 2014. And I guess while we're talking about the expense results, I think it's worth noting, I know there were a lot of questions along the way about will this translate to bottom line. And we've shared with you today that we exceeded the $85 million to $100 million. And I mean, I've only been here for a year, so a lot of this was in play when I got here. But full compliments to Bill and the leadership team, frankly. And I think, hopefully, the rest of you believe it when we said it goes off the bottom line. You can see that now in the results.

Yes. And if I may just give a little plug also, we have a lot of our associates listening in. I mean, this was a top-to-bottom initiative, and there's a lot of people who have contributed. And I'm proud that we were able to deliver beyond what we had stated a year ago.

Greg, even though you exceeded your expectations by a decent amount, you still only expect about $15 million to kind of carry into FY '14.

That really represents the annualization of cost decisions that were made in fiscal year 2013. Back in December, when we had our investor meeting with all of you, we talked about a concept more about targeting a 27% to 32% EBITDA margin range. We ended in the low 30s. We're not going to give specific guidance for this year. Our focus on expenses will continue forever, and we've got some good ideas. We've got some benefits coming in from last year. We're not going to give you specific numbers for this year. But I think, generally, in and around the margin percentages that we were at this year, plus or minus, is about where I expect it to be.

Your next question comes from the line of Gil Luria.

So first of all, on the Affordable Care Act, just to confirm, you're saying you don't expect a volume increase for fiscal '14. In 49 of the states, the advice is all going to be complementary, so no material impact to fiscal '14. First of all, I want to make sure we got that right. But then the second part is the pilot in that one state, are we talking about your day-to-day tax advisors providing that type of advice, an additional person that specialized in this in the store? Are you going to try and to fit it into the navigator box that was designed into the Affordable Care Act, maybe go for some federal grants? Can you tell us a little bit about that pilot?

So let me answer your first question. As we sit here today and what we're trying to disclose in our -- in the comments I made earlier is there's a lot of unknowns at this point. So as we go forward, we've done a tremendous amount of research in this area. I think we're as close to this as anybody else in our industry. It's very hard to say at this point what the impact is, so that's what we're trying to convey to you that as it goes forward, there's still lots to play out here. With regard to the potential for a of pilot in one state, here's what I would say: it would be a situation where I'm not going to go into describing, but where you would come into a Block office and you would be able to enroll with the assistance of someone who would, in effect, be licensed to enable people to enroll. I'm not going to get into what box is being checked or whatever, but just the user experience is someone would come to a Block office and be able to enroll in an exchange.

And then secondly, one of the key reasons, it seems like the overall tax funds this year were down. I think you discussed was the reduction in fraud or the attempts by the IRS to reduce fraud. Did you see this -- do you see evidence of this in the store? Did you have a report -- did your colleagues report from the stores that they had customers sit down and once they realized that the mechanism has changed for reporting some of those tax credits, get up and leave? Or is it the word-of-mouth among the fraudster community kept them out of the stores? Did you get any reports from the field that would indicate that?

Yes, I think, Gil, you're hitting -- I can't quantify it, but that's exactly the sentiment we got back, which is unfortunate. But I think this is one of the reasons why we do think it's important that the return preparer initiative, which is tied up in the courts right now, I think is important for the country. I think it's important for reputable tax preparers. We already comply with that because it's important for us with our brand and our reputation and our history that we provide accurate legal returns. But yes, your hitting on the qualitative feedback we received.

And finally, the Emerald Card, you grew that 9% on a 2-year stock. Have you also been able to get any uplift on the reload, on getting your employees and colleagues to get consumers to reload those cards, keep them longer? Has there been any level of success around that?

Yes, and Greg, if you want to add anything on this, we're not going to disclose specific numbers. But reloads are up, revenue per card is up, usage stats are up. This is building. In our view, we have a long way to go still. But the strides that Susan Ehrlich and her team made this year not only on enhancing the actual product, the value proposition around the product and the features, but also now as we start to become smarter about marketing and how we teach people how to use the card. The cards are now all personalized. We've made a lot of steps. So I'm very hopeful that as we go forward, this will continue to grow as we go on.

The strategy for Emerald Card, Gil, remains the same. We want to get more cards issued, although we have a very large number right now; we're effectively the third largest general purpose reloadable debit card program in the United States. But more importantly, in my opinion, is the year-round usage. And we shared statistics with the community before, which shows the average revenue per card per Block comparative to Green Dot and NetSpend, and we have multiples of opportunities to increase that. And so Susan and her team have worked very hard in features and functions, education, incentives, communication plans. And all of you on the phone, it's a great product. I encourage you to get one yourself if you don't already have it. But that's really what the opportunity is. And we've obviously just been about 3 months’ worth of vintage at this point, maybe 4 months of vintage. We can't -- we don't want to get into, what, with the month of June, at this point, already past our fiscal year. We saw some encouraging early results from the first 2 months. What I think we'll probably plan on doing this December when we have the next kind of major get-together, we'll talk a little bit more what our path looks like and some of the, I think, early results there.

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Your next question comes from the line of Thomas Allen.

When you announced the potential bank sale, it seems like tax season was a limitation you wanted to keep the bank for the tax season. So just as we think ahead for timing, should we expect you to sell the bank by next tax season?

So yes, thanks, Thomas, for the question. We continue to work very diligently on finding the right partner or partners. We had a lot of complexities that have to be dealt with. We have spent a substantial amount of time in the last 6-plus months through this process. We continue to be encouraged by opportunities, but it will always come down to finding the right deal at the right time with the right partner or partners. And the point at which we reach there, we'll let you know. Having said that, we are very sensitive to the tax season. And we don't want to disrupt the client experience, the tax pro experience, which is essential to delivering successful Emerald Card, Emerald Advance and the refund transfer to the 3 main products here. So I think your question, the way I would interpret it is, we're not going to announce something in the middle of a season and move it would be kind of the way I'd think about that so.

Well, the other thing I would add, Greg, and you certainly know this very well, the principle is correct that the tax season must be executed, that our clients do not see a disruption, that this is seamless to them. We will also have to get regulatory approval as we go forward. So it's not a simple sale on a closing. There will be a regulatory aspect of this. At the appropriate time, we will share more on this obviously.

So you start doing Emerald Advances, I think, around Thanksgiving. Does that mean that you would need to do something before then? And then if you add in the regulatory approvals too, does that mean you need to assign a couple of months before then to do it ahead of this tax season? Or can timing be pushed a little bit?

So you're correct that we opened up the Emerald Advance season this past year right before Black Friday, U.S. Thanksgiving. And that -- when you back up to the operational requirements of training, certifying, providing the materials to the offices, the system requirements, there is some operational lead time that's required from that. But in terms of specific, how do the timeline walk, I'm not prepared to talk about that right now.

Okay, that's fair. And then you talked about typical tax filing market growth of 1% to 2%. But just as we think about next year, you also talked about the potential that there were more extensions this year. From extensions, could we see market growth in fiscal '14 of 3%, 4%? Or should we think it's still probably pretty close to that 1% to 2%?

I hope you're right, Thomas. But extensions were up. I think a number of preparers have seen that. Obviously, we're working hard right now to translate those extensions into returns. It mystifies to some level what happened last year. I think that I go back to what I said earlier, the 50 years of data would indicate things would normalize. That's certainly our expectation. Folks probably talk about this more in December. But I think we believe things will normalize. But for conservative purposes, we might be thinking more in the 1% range. But we want to get the final numbers from the IRS in the next couple of months and take a look at that. But extensions, converting those extensions into returns could have an impact. But I don't think it would be anywhere close to the levels you just talked about.

Okay. And then finally, just on the RACs, can you give any color on or can you quantify the volume decline versus the revenue per unit increase? Did the delays have any impact? And I think it came in slightly below your expectations. What do you think drove that?

Yes, and, Greg, if you want to add anything, I think the -- we now have some doing the vacuum outside -- but I think, the season did have -- all the stuff that went on with the season did have a delay, did hurt us volume-wise. And I think we're looking hard at our user experience, the flow of our software. I mean, we're uncovering everything right now. To your point, we're disappointed that we didn't get up to the same level. Now clearly, we charged this year, so that was probably the biggest impact on the volume. But we want to hold ourselves to high standards, but I think that between charging for the project or the service and the convenience for the consumer and then also some of the disruption for the industry.

The only thing I would add, Thomas, on that is the main -- I think the main miss, in my view, was really just the lower volume for the overall industry was the main driver. There were some price-mix-driven things behind that, but that was really a smaller part of the delta.

Your next question comes from the line of Scott Schneeberger. Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: Just following up on the last questions. It makes sense that with regard to a bank transaction, your counterparties would want to look in and see how the full year completed. And it sounds like there's some puts and takes there. But would you feel stronger now than prior to the tax season with regard to consummating [ph] something with the results you have? And I'll stop there.

Well, so back when we announced the deal, we hired Goldman Sachs and First Annapolis as advisors and ran a full process. And every step of the way, we've had strong and varied interest from a lot of different financial institutions, a lot of quality institutions. And so we've obviously worked through that list at this point in time, and we've worked down a fairly narrow list at this point in time. But my expectation about getting a consummated deal was the same then as it is now. Obviously, you're going to get distracted by the operational details and all that kind of fun stuff. But I know that there is -- these are great products, and we're a great company. We run them really well. We're proud of what we do from a compliance perspective, and all the banks that have gone through the process with us have all come back with very positive feedback. So I guess I don't have a difference of opinion about getting a deal done.

Yes. And I would just go back; I thought Greg laid it out very well in the script. I mean, if you could do this in a way that had perfection, if you will, you'd announce the deal April 17 and you move on. But this is a unique situation. It's a captive bank; you need tax-related products. Partners need to understand that. Given the seasonality, we have to run through that. In today's world, compliance -- I mean, there's a lot behind the scenes here. As Greg put it, it's not a retailer selling its card portfolio or a retail bank selling to another retail bank. Having said that, the teams have done some tremendous work. I think there has been great progress here, but we just aren't in a position yet to say -- we will not delay when we feel we're in a position that we have struck a deal. Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: And just following up on that, is there -- you mentioned in the prior question, the reloading of the card is up, and I imagine that would be important to track for a counterparty. Do you think there's more time needed for your counterparties to review? Or is it that -- you mentioned you have it narrowed down, so it sounds like a good positioning. But would there be something extracurricular that requires more time?

So I can't comment necessarily what the counterparties are wanting to see. So I can't specifically say it's Emerald Card usage. But at this point, I mean all the transactional details from '13 have been digested and shared as appropriate. Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: And then you guys referred to the regulatory review period. Could you, one, just for all of us, give us a feel of what type of period, would that a 6 to 12 months, just a feeling? And also on your -- just your decision not to return capital during this period until you have a transaction, is that still the case?

So let me try the first half. I mean, Thomas, our business is the government. That's part of what we pride ourselves on is the ability to deal with government and regulators. I really don't see it that I could speculate. I think, hopefully, we'll position this well. The regulators will be pleased. We're taking steps to make this obvious to them with what we're trying to do, but I can't even remotely give you a date. Greg, do you want to take the second part of the question?

Well, just to be clear, we have returned capital during this time period when we paid quarterly dividends of $20-odd million per quarter, earlier in 2013 fiscal year, we bought back a substantial amount of shares that we talked about. In that entire time period, we were regulated. So we've been very clear that as a regulated entity, we have requirements with our regulators. But we have, during these pen [ph] periods, done capital reallocation to shareholders. Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: I'll switch it up. And the -- with regard to the ACA, did you see -- Bill, I understood what you were saying for the 2014, '15 and '16 and how it's going to be a build. Do you see a complexity pricing opportunity as soon as fiscal '14? And then a follow-up on that one.

And again, Scott, I don't want to dodge here, I haven't seen the first form. I don't know whether it's a simple form, it's a complicated -- so I don't want to dodge your question. I think the point we're trying to make here is I think we've done a lot of research in this area. I think we're as close to this as anyone in our space. But it's unclear at this point, and there's still a lot of knowledge we need to get. Certainly, we're approaching this, that on a variety of fronts, we do think that there is a retention opportunity. Ultimately, we think there is a monetization opportunity, but I'm not trying -- I'm trying to be as open as we can be here. We just don't know at this point. But believe me, we're staying very close to this. Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: That's fair, totally understandable. Following up on that, you mentioned the one state, could you let us know if that's a larger or small state? And is there the potential for more states with regard to the exchange process?

Do you mean by geography, population or... Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: Any way you want will be fine.

If you want, all 50 of our states, Scott...

And territories.

And territories. Yes, well, I mean, at the appropriate time, we'll talk -- I'm not going to talk about that for competitive reasons, obviously. Scott A. Schneeberger - Oppenheimer & Co. Inc., Research Division: Okay, fair enough. And I realize it's getting late. If I can sneak one more in, on the tolling agreements, Greg, could you just speak a little bit to more to that? I'll leave that as an open-end question, which is to help us better understand what may happen in future quarters and how the process is going [ph] over thinking?

So I believe this is a new record for H&R Block that it was question 31 or something, where we got to Sand Canyon, of the development. So the future is uncertain. I guess what I would say actually is for the accrual for representation and warranty reserves that is going to be reported here officially with the SEC shortly, what we've disclosed to you today, is the best estimate of that liability. So I can't -- what I did say is based on the methodology change, you may expect more volatility, but we'll have to wait and see.

Your next question comes from the line of Michael Millman.

Several questions as well. On the EA, on the card, it looks like your bad debt was up, yet your fees cards were down. Talk about that a bit?

I can, Mike. The bad debt always needs to be put in relationship to the revenue line when you're in financial services, specific to the Emerald Advance, which is where the majority of that sits. This past season, we continue to enhance the program. We had a longer time period. We invested more into the credit score remodels, better education. We had, I think, a better approach to the business. We also, as we've experimented with historically, opened it up to new clients, as well as prior clients. And really what you see that delta is just the change in sort of that profile of clients. But in my mind, it was a good decision. And when you look at the bottom line, we were okay with the results there.

What extent did those new clients become clients of the tax business?

What proportion of the time does an Emerald Advance client turn into a -- or an Emerald Advance client turn into a tax-preparation client, is that the question, Mike?

Typically, this year, of the new clients.

Yes, Mike, this is Derek. It's actually about 92% to 93% generally come back for tax preparation.

And that was the case this year as well?

I believe that's the case, yes. If not, we'll get back to you.

In terms of revenue per return, if you will, could you talk about the percentage of Free EZs this year versus last, the increased pricing on the non-Free EZs than last?

So I think, Mike, we're going to stick by what we disclosed was the overall pricing was up 1.7%. We don't talk about specific number of returns from EZ. It's a promotional activity for us. It's been very effective for us. But I'm not going to get into the specific numbers. And as I spoke with Kartik earlier, the pricing, I would stick with the 1.7%.

And then your focus on profitability, why aren't you pushing price in an industry that's been known for non-elasticity?

Yes, I think that as we've indicated last December, we made some very considered choices about pricing this year. We chose to reduce some prices, which were clear on our pricing boards. In other areas, we changed the pricing. We made some moves during the year. We really focused on our discounting. So it's a complex web here. And I think we're-- every year, we'll evaluate the economic situation, our situation. And so I would say that we certainly delivered slightly above what we had indicated in December. And as you obviously know from your years here that we're hard at work, trying to figure out what our plans are for next year. And we'll talk about that more in December.

This year, the 3 brands looked like they kind of underperformed a bit. Who's taking that incremental share and why?

I'm sorry, which -- what brands are you talking about?

I'm talking about Block, I'm talking Jackson Hewitt, and Liberty, if and when you make adjustments to their report.

Yes, again, I'm not going to comment on any competitor's situation. I think that overall, with the industry down, we're still trying to -- awaiting a full review, if you will, of where things went. But it's pretty obvious that the primary competition in this space is independents and CPAs. But again, with the overall industry down, it's hard for me to say at this point.

Can you give us an update on certification?

The return preparer certification?

Yes, please.

I think it's an important area that we are in full support. I think any reputable tax preparer is. It is tied up in the courts right now. We believe this is important for Congress and the IRS and to work with the courts. I think this was a bad decision. I think it's completely misunderstood. But really, this should be something that -- given the importance of filing tax returns, given the situation the country has with debt, this is -- this doesn't make a lot of sense for this not to be part of our industry. But right now, it's tied up in the courts and, hopefully, a resolution will be had, so that everybody has to use the standards that H&R Block and others use.

Any guess on timing?

We'd love to have it tomorrow, but we have no other estimate than that.

And Mike, just for clarification, I mentioned 92%, the Emerald Advance clients return back for tax preparation, that was last year's rate. This year's rate was 91%, so it was down 1 point.

And we have no further questions at this time.

Thank you. We appreciate your participation in the call, and we look forward to talking to you all soon. Thank you, Keisha.

You're welcome. Ladies and gentlemen, this concludes today's conference call. You may now disconnect.