H&R Block, Inc. (NYSE:HRB) Q2 2023 Earnings Call Transcript

H&R Block, Inc. (NYSE:HRB) Q2 2023 Earnings Call Transcript February 7, 2023

Operator: Thank you for standing by, and welcome to H&R Block’s Second Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation there will be question-and-answer session. I would now like to hand the call over to Vice President, Investor Relations, Michaella Gallina. Please go ahead.

Michaella Gallina: Thank you, Lateef. Good afternoon everyone and welcome to H&R Block’s second quarter fiscal 2023 financial results conference call. Joining me today are Jeff Jones, our President and Chief Executive Officer, and Tony Bowen, our Chief Financial Officer. Earlier today, we issued a press release and presentation, which can be downloaded or viewed live on our website at investors.hrblock.com. Our call is being broadcast and webcast live, and a replay of the webcast will be available for 90 days. Before we begin, I’d like to remind listeners that comments made by management may include forward-looking statements within the meaning of federal securities laws. These statements involve material risks and uncertainties, and actual results could differ from those projected in any forward-looking statement due to numerous factors.

For a description of these risks and uncertainties, please see H&R Block’s Annual Report on Form 10-K and Quarterly Reports on Form 10-Q, as updated periodically with our other SEC filings. Please note, some metrics we’ll discuss today are presented on a non-GAAP basis. We’ve reconciled the comparable GAAP and non-GAAP figures in the appendix of our presentation. Finally, the content of this call contains time-sensitive information accurate only as of today, February 7, 2023. H&R Block undertakes no obligation to revise or otherwise update any statements to reflect events or circumstances after the date of this call. With that, I will now turn it over to Jeff.

Jeff Jones: Thank you, Michaella. Good afternoon, everyone, and thanks for joining us. Today I will begin with a summary of our Q2 results, progress on Block Horizons, and the momentum we have entering the tax season. Then, Tony will provide details on our financial performance, and we’ll open it up for Q&A. Second quarter results met expectations and we’ve performed well in the first half of fiscal 2023. I feel confident about our positioning as we move into tax season and the third quarter, and I’m pleased to reaffirm our full year guidance. In the second quarter revenue grew 5% to last year on continued business momentum and a strong ending to the 2022 tax season. We are seeing signs that consumers are feeling more pressure this year versus last year given the rollback of government stimulus and the broader inflationary environment.

As a result, clients turned to H&R Block in Q2 to bridge the gap in their time of need, and we saw higher demand for our Emerald Advance product in December, which we view as a good leading indicator for tax season. On the expense front, we managed well despite the macro environment, and our capital allocation practice remains solid as we repurchased another 2% of shares outstanding in the quarter. Turning to Block Horizons, I continue to be pleased with the progress we are making. Starting with Small Business, revenue growth was strong as a result of the extended filing season and our bold marketing of the up to 30% price advantage we provide over CPAs. As we’ve talked about, we’re also building out our year-round services for bookkeeping and payroll, and we are seeing positive adoption signals on these products.

We are also feeling good about the value our new business formation tool is offering clients. There are often tax and legal benefits to small business owners from being incorporated, and we built this product with a partner to answer this clear need, with the added benefit of being a revenue driver to Block. It also provides an opportunity to increase tax prep revenue if we file both a personal and business return the following tax year. Another way we’re moving this segment forward is increasing training and certification levels. Half of our small business tax pros have achieved the advanced level, which focuses on levers to directly drive customer and revenue growth through 13 hours of additional training. In all, I’m very happy with the results we are producing in Small Business.

The second component of our Small Business imperative is Wave, which is a one-stop money management platform for small business owners offering invoicing, payments, accounting, banking, payroll, and advisory services. For the quarter, revenue growth was 13%. Our main focus is accelerating revenue growth and determining the ways we’ll drive long-term profitability. Moving to Financial Products, we were pleased to roll out Spruce in the Assisted channel via all company and franchise offices in January. We knew that educating our tax pros on the clear and different value propositions of Spruce and the Emerald Card would be critical to the success of both products. As such, we added dedicated training and feel good about the readiness of our field and how we’re informing clients.

The goal for Spruce this season is to educate clients on its value, generate sign-ups, and ideally have all or a portion of the tax refund deposited as an initial step. The next steps are about ensuring that once an account is open, clients are engaging with the platform, setting up direct deposit, and using Spruce for their day-to-day purchases. In just the first few weeks, Spruce is living its purpose of helping our clients to be good with money and enabling them to grow in their own personal financial confidence. In fact, our very first Spruce sign up in the Assisted channel came from a longstanding H&R Block client who came to her appointment with an interest in Spruce because she had seen our marketing beforehand. This client had historically deposited her refund at another bank, but after learning about Spruce’s specific value proposition and features, such as low fees, the ability to easily deposit cash at retail locations, the fee-free ATM locator in the mobile app, and FDIC backing, she chose to put her refund balance on Spruce.

At the same time, we are continuing to innovate the platform. Importantly, we are making it easier for clients to convert their payroll to Spruce – they will soon be able to set up direct deposit electronically from within the app, skipping the manual forms and phone calls to HR. Building on our learnings from the DIY launch last year, our marketing approach for Spruce was strategically planned for before, during, and after the tax event. As of December 31st, we had 171,000 Spruce sign ups and $117 million in customer deposits. Given the initial launch in the Assisted channel, we look forward to updating you on the trends and learnings after tax season. Turning to Block Experience, we are blending technology with human expertise, and we continue to make great progress.

This imperative underpins many of the ways we will win in both Assisted and DIY, and our go to market strategy reflects these advancements this year. Let me share more about it and why we feel confident in our ability to execute this season, which just began with e-file opening on January 23rd I’ll start with the Assisted channel. We are leveraging our technology to empower clients to choose how they want to be served – fully virtual or fully in person, and everything in between. You’ll recall that last season we increased the use of virtual tools by more than three times and we are continuing to make progress on client adoption. We are also improving the operational efficiencies within our innovative fulfillment network. You’ll recall we piloted this last year and are further rolling it out this season.

The network benefits our clients by allowing them to more quickly access tax professionals who have capacity and increases our productivity. While the employment market is currently a challenge for many companies, we have successfully met our hiring and staffing goals. Our tax pros tell us that they return to H&R Block year after year because of our culture. They build strong relationships with their clients and teams, and are passionate about helping people. In addition, we hear positive feedback about the flexibility we offer related to scheduling and remote work. In Assisted, we are taking modest price increases this season. Despite inflation being materially higher, we feel that these modest price increases are appropriate as we continue to deliver a great value for price.

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We’ve done the work to position ourselves for success and I’m looking forward to the rest of the season. Turning to the DIY channel, we have spent a significant amount of time understanding how we can return to share gains by speaking to both our clients and our competitor’s clients, and we came away with clear learnings: there is a large awareness gap that H&R Block has as a competitive product, DIY filers do not believe that it is easy to switch to new software, and they do not want to be surprised on pricing when they get to the end of the experience and are ready to file. With these three challenges in mind, we responded. First, on the awareness front, we’ve allocated more of our marketing spend to DIY-specific messaging and are boldly addressing the clear advantages of our product, such as a better product experience, a price advantage to our largest competitor, how easy it is to switch, and the access to our network of expert tax professionals for assistance.

We’re also identifying underpenetrated markets where we have a large opportunity and are going deeper in these regions with even more personalized messaging. As you may have seen already, our television advertisements are focused on bringing top of funnel awareness and addressing the ease of switching, which we know is the biggest barrier. We then leverage digital to optimize conversion, such as search, display, and social content, like TikTok, Instagram, and Pinterest, to deliver messaging on the value proposition I just discussed. In addition, reflecting trends of the creator economy, we have targeted campaigns for groups such as the self-employed and students. Second, we made it easier than ever to switch, including customized flows for clients moving from TurboTax.

With just a couple of clicks, clients can drag and drop their previous year’s TurboTax return into the H&R Block online flow, which then auto populates into the current year tax flow. We’ve also created simple, step by step instructional videos to demonstrate this to clients. At the same time, we launched newly built AI technology, which is powered by models from millions of returns and AI algorithms, and other technology such as optical character recognition. This new feature automatically scans the prior year TurboTax return to identify if the client may have missed out on refund dollars. If it identifies opportunities, we notify the client and connect them to one of our expert tax professionals who can help them file an amendment. Clients only pay if they amend their return to get an additional refund.

This technology is a gamechanger, and as the possibility of a recession looms, it’s important that consumers get every available dollar of their tax refund. Finally, to solve for pricing transparency, we present price previews to clients throughout the DIY experience so there are no surprises when they get to the end. Like in Assisted, we are taking modest price increases this year. We feel very good about our improved positioning and go to market strategy in DIY this season. The progress we continue to make across the business is significant, and I am excited about what is ahead. With tax season upon us, and after spending time in the field already, I can’t wait to see what we’ll accomplish for clients this year. With that, I will now turn things over to Tony to discuss our financial results.

Tony Bowen: Thanks, Jeff, and good afternoon, everyone. Our performance continues to be on track for the first half of the year and, as a result, we are pleased to reaffirm our full year outlook for 2023, as Jeff mentioned earlier. In the second quarter, we delivered $166 million of revenue, which increased 5% or $8 million to the prior year. This was primarily driven by client volumes and net average charge improvements as we had a strong end to the 2022 tax season, partially offset by lower Emerald Card revenues. As we mentioned last quarter, we expected this impact due to Advanced Child Tax Credit payments being loaded on Emerald cards last year. Total operating expenses were approximately $450 million, an increase of about 3% or about $13 million, primarily due to higher corporate and field wages, along with increased bad debt expense.

This was partially offset by lower consulting and outsourced services as well as favorable developments in insurance loss reserves. EBITDA was a loss of approximately $246 million, an increase of 3% or $6 million to prior year. Interest expense was approximately $19 million, a decrease of about $4 million, or 18%. Recall that in June of 2021 we issued notes at 2.5% and paid off our $500 million 5.5% notes early, in May of 2022. This was partially offset by increased interest expense on our CLOC due to higher interest rates. Although we are seeing higher interest expense on our short-term borrowings, this will be more than offset with higher interest income in the fourth quarter when we enter a positive cash position, assuming interest rates remain similar to current levels.

Pretax loss was effectively flat to prior year at $298 million and our effective tax rate was 25.9% compared to 36.7% last year. As a reminder, our effective tax rate in fiscal year €˜22 was 15% and we expect it to increase to approximately 22% in fiscal year €˜23. Loss per share from continuing operations increased from -1.09 to -1.43, while adjusted loss per share from continuing operations increased from -1.02 to -1.37, primarily due to the larger net loss from lower income tax benefits in the quarter and fewer shares outstanding. As a reminder, the only adjustment we are currently making to adjusted earnings per share is amortization related to acquisitions. Turning to guidance, we’re pleased to reiterate topline growth, EBITDA that outpaces revenue, and EPS that grows even faster.

As a reminder, we did not assume any benefit from 1099Ks in our outlook. We also remain confident in the longer-term target we provided in August, of adjusted EPS growing double digits annually through fiscal year €˜25. Our capital allocation practice remains strong. In Q2 we bought a total of 3.2 million shares for $130 million at an average price of $40.22. As Jeff mentioned, this was another 2% of our shares outstanding, for a total of $350 million or 5% of shares repurchased in the first half of the year. Given our narrow trading windows, we have historically executed most of our share repurchase in the early part of the year. Overall, I believe this is a great use of capital and I feel good about what we have accomplished this year. Before moving into Q&A, I’d also like to highlight the strength of our business during periods of economic downturns.

Both the tax industry and H&R Block have a history of resilience. The industry is most correlated with employment, which remained strong in calendar year 2022, boding well for the tax season in ’23. And, as trends over the last couple of decades have shown, when times are tough clients want to ensure they are getting their maximum refund by turning to our trusted brand. We’ve also seen more small businesses formed during tough economic times, and if the backdrop deteriorates more meaningfully, our government has a history of stepping in to provide stimulus distributed through the tax filing system. You’ll recall our biggest compensation line item is for tax pros, which is largely variable in relation to filing volumes – meaning we can flex expenses in line with business trends.

And as I mentioned before, rising interest rates are actually a near term positive for H&R Block. The bottom line is, our industry volatility is low and our business is resilient. In summary, we feel very good about the performance of our business and are looking forward to the rest of this tax season. Our next update, including filing volumes, will be on our Q3 call in early May. With that, I’ll now turn it back to Jeff for some closing remarks.

Jeff Jones: Thanks, Tony. In summary, we are pleased with our first half performance and are confident in our ability to drive value for shareholders through our business results and capital allocation practice. As we end our prepared remarks, I would like to sincerely thank our hard-working associates, franchisees, and tax professionals, who inspire confidence in our clients and communities everywhere. With tax season in full swing, our Block family is hard at work and I cannot thank them all enough. Now we will open the line for questions.

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Q&A Session

Operator: Our first question comes from the line of Kartik Mehta of Northcoast. Your line is open, Kartik.

Kartik Mehta: Thanks, Yes, hi Jeff, Tony. Jeff, just, I know it’s early and whatever color you can give would be appreciated. Just how the tax season has started and is it in line with your expectations better than expectations, I guess, worse than expectations? Any commentary you could give from what you’re seeing early on?

Jeff Jones: Hi Kartik. Thanks for the question. Yes, obviously we won’t get into details about the current quarter and season, but I will say that we have seen clients filing earlier in both the Assisted and DIY channels and we think that’s true for the broader industry as well. And if it makes sense, when you think about those that really need their money, their refund and with stimulus payments ending from last year, so that’s one insight I can provide, otherwise we probably don’t want to get too deep into our current performance.

Kartik Mehta: That’s fair. And Jeff, just I know Block Horizons strategy small business, when you look at the end of the season, what would you define as success? I guess what metrics are you looking at to see if the program is working up to your expectations or if there is some tweaks that might be needed?

Jeff Jones: That’s great question and obviously there are a number of different metrics we’re looking at financial performance, operational, because there are a number of pieces to the small business strategy. I think if I start at the top, we’ve had two really good years in small business performance and so we expect to continue to see Assisted tax growth for small businesses, that’s a core component of the strategy. We’re also building year-round capabilities in bookkeeping and payroll. So we want to see that we’re not only growing those businesses but operationally, we’re able to deliver the kind of experience that we want and we know clients expect. And then, as you know, we’re also launching new products like the business formation service, that’s a brand new product and so for a year like this, when it’s coming out of the gates, we’re looking closely at operational performance and making sure that we’re really delivering for clients when they raised their hand and say they’re interested in that service.

So a lot of different metrics. But we feel very good about the small business imperatives performance over the last couple of years and the expectations that will continue.

Kartik Mehta: Thanks, Jeff. I really appreciate it.

Jeff Jones: Thanks Kartik.

Tony Bowen: Thanks Kartik.

Operator: Thank you. Our next question comes from the line of George Tong of Goldman Sachs. Your question please, George.

George Tong: Hi, thanks, good afternoon. We’ve seen estimates out there that this year refunds on average will come in lower which could potentially make consumers more price sensitive. Can you discuss your expectations on how lower refunds might impact the elasticity of consumers, especially the lower end with subprime consumer that may be a little bit more stretched given the effect of inflation? And what the ultimate impact could be on market share performance given some of those dynamics?

Jeff Jones: Hi, George, it’s Jeff, I’ll kick this off. I mean I think at the highest level to start, we don’t control the size of the refund. So we do the work for the customer, we deliver the experience and the outcome but what we do control is the price and the experience and how that adds up to value for the customer and I think that’s one of the reasons why we are taking the steps we’re taking on pricing this year is one example, knowing that every dollar matters, so expertise matters and despite a much faster, higher inflationary backdrop, we’re only taking nominal price increases in Assisted to make sure that value is really strong. So that’s really what we can control and we just continued to be focused on the best experience providing expertise in making sure that the price value equation continues to be strong, because we see it strong and that’s been several years of building that as we’ve talked about.

Tony Bowen: Yes, George. I would just layer on, I mean I think we do expect that refunds could come down a little bit this year as you remember, last year they increased. But even if they do, I mean early season clients in particular, still getting very large refunds relative to obviously the price they’re paying for their services and many of them are leveraging products like Refund Transfer to pay for that tax preparation. So we don’t expect that to be a near-term issue that would impact any kind of client volume.

George Tong: Got it. That’s helpful. And then can you refresh your views around the topic of tax filing complexity this year and its impact on Assisted net average charge? What are some of the puts and takes that you expect in this tax season compared to last year’s tax season?

Jeff Jones: Yes. We can tag team again, but I think starting with, it’s obviously been a few unusual years with a number of different things that were causing the filer to how to think about federal stimulus, unemployment benefits et cetera, and we expect this to be a more normal year in general. That said, we continue to see consumer opting for expertise, even in the DIY channel and looking at growth of products like Tax Pro Review, for example where they start as a DIY filer but at some point in the process, recognize they have questions in — push to help button to get their questions answered or also may turn it over to work for us to finish for them. So even with a normal – in air quotes a normal year, we still see the consumer opting for expertise in, that’s why we like the way that we’re positioned with our network of experts.

George Tong: Got it. Thank you.

Jeff Jones: Thank you.

Tony Bowen: Thank you, George.

Operator: Thank you. Our next question comes from the line of Scott Schneeberger of Oppenheimer. Your line is open, Scott.

Scott Schneeberger: Thanks, good afternoon. I guess, let’s with the advertising campaign with regarding DIY really stepped it up this year and very much going against your largest competitor. Just wanted to delve into that a little bit more, how are your marketing dollars, advertising dollars allocated this year? What type of increase year-over-year this year versus last if any? And then how are you approaching Assisted in DIY as far as balancing those dollars versus past years? And then also kind of your media channels, certainly have been very active on TV with the DIY. Just curious what more you can share about the marketing approach? Thanks.