H&R Block, Inc. (NYSE:HRB) Q3 2024 Earnings Call Transcript

H&R Block, Inc. (NYSE:HRB) Q3 2024 Earnings Call Transcript May 9, 2024

H&R Block, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by and welcome to H&R Block’s Third Quarter Fiscal Year 2024 Earnings Conference Call. [Operator Instructions] I would now like to hand the call over to Michaella Gallina, Vice President, Investor Relations. Please go ahead.

Michaella Gallina: Thank you, Latif. Good afternoon, everyone, everyone and welcome to H&R Block’s third quarter fiscal year 2024 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 reconciled the comparable GAAP and non-GAAP figures in the appendix of the presentation. Finally, the content of this call contains time-sensitive information accurate only as of today, May 9, 2024. We 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. I will begin by providing commentary on the third quarter detail on our tax season performance and discuss our Block Horizons progress. Then Tony will share more on our financials and we’ll open it up for Q&A. Beginning with Q3 results ending March 31, revenue grew 4%, EBITDA grew 6% and EPS grew 18%. In the quarter, performance was driven by improvements in net average charge or NAC in both assisted and DIY. DIY volume growth and ongoing disciplined expense management, based on how we ended tax season and our third quarter performance, we now expect to finish the year near the high end of our outlook. Tony will share more thoughts on outlook in a moment.

Turning to the tax season. After a bit of a slow start, the overall industry grew about 2% this year, with DIY growing 3% and assisted growing about 1%. Our data indicates that last year’s California extension had a positive impact on category growth this year. Our overall market share was about flat, driven by share gains in DIY that were offset by assisted. Let’s discuss our results in more detail, beginning with DIY. Our formula for success is to offer an award-winning product, make it easy for clients to switch and price competitively. This strategy continued to work and we’re very pleased with the results in our DIY business. We had meaningful growth in paid clients and Mac the season which translated to strong revenue growth. We have an intentional focus on driving more paid SKUs and this effort is working well.

You’ll see in the appendix of our presentation that for the first time, we broke out free and paid DIY filings in the volume table to add additional transparency. We saw an increase in taxpayer identity fraud in the industry, concentrated in free SKUs that were e-file accepted by the IRS. Beyond our own fraud prevention measures, we’re in discussions on how the IRS and industry can partner to reduce fraud in the future. As you can see, our paid DIY growth significantly outpaced the DIY category. Through April 30, paid volumes grew 6% and many of these filers came from TurboTax. We saw strong MAT growth of 7% in paid clients. And at the same time, customer satisfaction metrics including ease of use and price for service improved. In addition, we focused on curated experiences to help self-employed workers feel more confident in their tax outcome which resulted in notable increases among those filers.

Our Gen AI-powered AI tax assist performed well. As we’ve shared, this innovation was launched for the first time this year. Feedback indicated that the tool was easy to use and helpful in the tax prep process and clients found value-added. Importantly, we saw greater conversion among new clients who leveraged AI tax assist. Both AI tax assist and human help were included at no additional charge in all of our DIY paid online SKUs which we believe is a competitive differentiator. As a result, we exceeded our operational metrics with human help and believe this combination provides clients with the confidence they need in DIY. We also continue to see more DIY clients accessing human help with Tax Pro Review which grew more than 15%, continuing its multiyear trend of double-digit annual growth.

Overall, we feel great about the help we’re providing our DIY customers. Now, let’s turn to our consumer tax-assisted performance. For several years, we’ve had a focus on transforming our assisted tax client experience. We’ve been improving the quality and value of our service. We’ve developed plans to attract and serve more complex and higher lifetime value clients. We’ve made tangible progress in building better digital options for our clients and tax pros and we’ve been modernizing our technology across the board. This year, we saw many of these efforts yield encouraging results. We saw client growth in each segment above $60,000 of income. Like last year, our fastest-growing segment was those in the more than $100,000 of income. Our efforts slowed the decline of EITC filers which was a goal for this year but we still have work to do in lower income segments.

In total, our assisted volumes declined about 1% through April 30. However, modest pricing increases alongside the mix shift among clients led to 4% net growth while improving client satisfaction scores. Our continuous improvement of MyBlock led to double-digit growth in the number of authenticated accounts and a nearly 20% increase in the number of documents uploaded to share with the tax professional. We also saw growth in the number of assisted clients working with us completely virtually increasing more than 25% year-over-year. We expect this number to continue to grow in the future. Additionally, our Gen AI efforts to improve the customer experience in our call center operations provided great learnings in its initial pilot. We were pleased with its accuracy which was relatively high compared to similar offerings.

We are looking forward to applying our learnings in order to expand the usage so that we can better serve more customers at a lower cost. While I’m proud of our progress, I also recognize that our pace of change in field offices this year was high. We rolled out our new tax platform to all company and franchise locations. We introduced a new phone system. We set lofty goals for scanning more documents in the office and printing fewer pages. We modified our Tax Pro compensation model and we introduced an entirely new system for measuring performance down to each tax professional. These kinds of changes are necessary to our future but it was a lot in 1 year. While the appointments and visits to our tax offices were encouraging, too many clients that started tax prep ultimately did not finish and I see a large opportunity to ensure those who start with us become happy and loyal clients and this will be a major focus in fiscal ’25.

Now, let’s move on to our Block Horizons imperatives. We continue to see positive trends in assisted small business tax. Through April 30, MAC increased 3%. We’re outperforming among higher-income small businesses and our focus on growing our share of the entity return market is paying off. Bookkeeping and payroll services continue to increase double digits driven by our dedicated sales force. Overall, we are optimistic about the trajectory of small business and the long runway of this opportunity ahead. Moving to Wave; revenue growth was 7% in the quarter. As you recall, a couple of months ago, Wave launched a new paid tier subscription service and a new paid receipt product. While early monetization has been better than anticipated, we feel good about the strategic direction as we execute against our goals of accelerating revenue growth and driving profitability.

Turning to financial products; this was the second season at Spruce our mobile banking platform was offered in the assisted channel. Since launch through April 30, Spruce had 470,000 sign-ups and $852 million in customer deposits. We saw strong growth this year and customer deposits have nearly tripled from last year. We’re starting to gain traction with how we offer this product and I’m proud we saw significant growth this year. This season was the first time we offered assisted and DIY tax in the Spruce app and we saw good results. Among new Spruce clients that also filed a tax return, 54% were new to H&R Block and we are pleased with the low associated customer acquisition cost. We continue to make significant improvements and release new features on the platform.

Last month, Spruce launched a variable interest rate feature that pays 3.5% APY on savings account balances which is 7x the national average. There are no monthly fees and no minimum balance or direct deposit requirements, making it an appealing option for clients versus other competitors in the marketplace. We’re proud of how Spruce is delivering on its mission to help people take control of their finances. Stepping back to review results holistically. In DIY, we are pleased with our strong performance driven by paid clients and paid NAC, Tax Pro Review growth, customer satisfaction scores and the launch of AI Tax Assist. In assisted, I’m happy to see our brand resonating with higher-value clients, the MAC increase this year and the strength in assisted small business tax.

At the same time, we can improve the experience for assisted clients. And with so many new changes now behind us, I’m excited to see the improvements I know we can make. From a financial perspective, as I shared earlier, we expect to deliver results near the high end of our outlook ranges which means top line growth, robust cash flow generation and double-digit EPS growth that allows for continued return of capital to shareholders through dividends and repurchases. With that, I will now turn it over to Tony to discuss our financials.

Tony Bowen: Thanks, Jeff and good afternoon, everyone. In the third quarter, we delivered $2.2 billion of revenue which grew 4% or $91 million to the prior year. The increase was primarily due to a higher net average charge and higher company-owned volumes in assisted and higher volumes in NAC and DIY, partially offset by lower volumes in franchise locations due to franchise acquisitions. Total operating expenses in the quarter were $1.3 billion, an increase of $27 million or 2%, primarily due to higher field wages because of greater company-owned volumes and higher legal fees and settlements, partially offset by lower marketing and advertising expenses. EBITDA was $964 million compared to $910 million in the prior year, an increase of 6%.

Interest expense was $26 million compared to $22 million in the prior year due to higher borrowings on our line of credit and the higher interest rate environment. We will benefit from higher interest rates as we move into a positive cash position. Pretax income increased by $52 million to $907 million, primarily due to higher revenues in the current year and our effective tax rate in the quarter was 23.8% compared to 24.5% last year. We did not execute any share repurchases in the third quarter. You’ll recall that given our narrow trading windows, we typically execute most of our share repurchases in the first half of the year. In Q1 and Q2, we completed $350 million of share buybacks or another 5.5% of shares outstanding. Both earnings per share from continuing operations and adjusted earnings per share from continuing operations increased 18% to $4.87 and $4.94, respectively.

We continue to be opportunistic in our franchise acquisitions which are a core driver of our longer-term revenue growth target of 3% to 6%. This year, we have purchased 156 offices which is lower than the approximately 200 offices we repurchased last year. We feel great about franchisees’ willingness to sell to us and are pleased with how this strategy supports our longer-term revenue and earnings growth. As Jeff shared, based on how we ended the tax season and our performance in the third quarter, we now expect to finish the year near the high end of our outlook. We also expect our effective tax rate to be in the 21% to 22% range. As I’ve said for a long time, despite year-to-year nuances, the strength of our capital allocation story remains the same.

We produce consistent cash flow, pay a growing dividend and buy back a meaningful amount of shares. Fiscal year ’24 will be another year of top line growth, strong cash flow generation and double-digit EPS growth. Now, I will turn it back over to Jeff for some closing remarks.

Jeff Jones: Thank you, Tony. As we end our prepared remarks, I want to thank our tax professionals, associates and franchisees for their efforts this tax season. Together, we are continuing to deliver on our purpose of providing help and inspiring confidence in our clients and communities everywhere. I look forward to sharing more details on our year-end call in August. Now operator, we will open the line for questions.

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Q&A Session

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

Kartik Mehta: Jeff, maybe just on the assisted market share loss on the EIT side. What could the company do, do you think to mitigate that and maybe even turn that around?

Jeff Jones: Kartik, thanks for the question. Listen, this has obviously been a challenge for us for a long time and we remain focused on trying to solve it. And we think it’s a combination of the right message in the market, the role of refund advance, getting pricing and value right in the moment when we’re providing service and we remain focused on continuing to slow the decline and ultimately turn it. I am very happy with what we’re seeing on the other end of the spectrum. We continue to attract higher-value clients, higher AGI, more complexity. So it is definitely a balance of both but we’re not going to let up our focus on continuing to try to make that value for the under $30,000 customer better and better, while we’re also attracting more clients at the higher end.

Kartik Mehta: So would you say, Jeff, was almost all of the market share loss, the result of the EITC clients.

Jeff Jones: It was a big part, Kartik but as you heard in my prepared remarks, First of all, there are a number of great things we didn’t assisted this year. I don’t want to overlook that. But you also heard me mention that I just saw too many experienced breaks overall than assisted. I spend more time in the field this year than I ever have. And I just saw too many examples of brakes in the experience standard that we have for our clients really across the board and definitely at lower income and keep in mind, when I talk about this, I’m talking about clients that chose Block, made an appointment, came to the office, started tax prep and for a variety of reasons, didn’t complete. This year, for the first time, we started surveying those clients.

And actually, the number 1 reason they told us was we did not demonstrate enough expertise. And the number 2 reason they told us was we didn’t do a good job of managing their expectations. And so while that’s obviously frustrating, this is a significant number of clients that are choosing us coming to the office and starting. And I know we can do better at executing and I’m excited about what that volume opportunity really represents.

Kartik Mehta: And then just 1 last question, Jeff. Obviously, a very good on both the assisted and DIY side. As we move forward, do you think you’d be able to sustain that type of NAV? Or was this a little bit of an unusual year?

Jeff Jones: Well, I think our strategy for NAC is unchanged. I mean we feel very good about the value we’re delivering in general across the board. Obviously, the dynamics are different in DIY versus assisted. In DIY, we continue to believe that with the mix changes and modest price increases, we can continue to see that NAC increase. We pay close attention to competition there, obviously. And in the assisted business, every year, we’ll do the same thing. We’ll wrap the season. We’ll evaluate client feedback which, by the way, for those that we’re surveying continues to remain strong on value for price paid and we continue to think that price can play a role in our growth. That has not changed.

Operator: Our next question comes from the line of George Tong of Goldman Sachs.

George Tong: You mentioned both your AI tax assist and human help were included at no additional charge in all of your DIY paid online, can you elaborate on that in your monetization strategy and how going forward you might look to potentially monetize Gen AI or human help within DIY.

Jeff Jones: Yes. George, thank you. I mean, first of all, including it in our paid SKUs, I’m sure, was part of the strength and growth in our paid SKUs. That’s a great value proposition for customers. And so with respect to what we do next on monetization, especially with Gen AI, I’d say it’s just too early to say. I mean we believe that Gen AI can play a strong role in improving customer experience. As you also heard me mention, we saw the new clients that engage with AI tax assist convert at a higher level. And so we’ll continue to learn and test different ways of including Gen AI in our DIY products. But I feel very good about year 1 at such an early stage of what we saw this year. Of course, Tax Pro Review is another product that’s performing very well, where we’re monetizing human help. And that DIY filer chooses to get access to humans and that product has been growing very, very nicely for many years in a row now. So that’s another way we’re monetizing.

George Tong: That’s helpful. And then last year, there were a couple of filing extensions. You previously noted, California had the biggest impact. Can you estimate how much the filing extensions from last year potentially impacted the growth from a comp perspective this year? And if any of the filing extensions this year would impact results?

Tony Bowen: George, it’s Tony. So as Jeff said in the opening comments, we think the industry grew about 2% and we think in California, probably had close to 1% impact on that year-over-year growth given the extension from last year. Obviously, the other smaller states had some marginal impact. I think most of it is California and this year, while there have been some extensions, we think they’re relatively small versus what we saw last year. So we don’t think it’s having a material impact on the performance of the overall industry this year.

Operator: Our next question comes from the line of Scott Schneeberger of Oppenheimer and Company.

Scott Schneeberger: I’d like to start out, Slide 7 highlight that many of the filers, you took share relative to industry in DIY. Many of those filers came from TurboTax. Was that specifically paid? Or was that overall? Could you just elaborate on how you track that and what you saw.

Tony Bowen: Yes. Scott, I mean, we obviously have some insight based on when clients upload documents from prior years and where they likely filed and I think it’s across the board. Obviously, some of those are starting to free skew. Some of those are in the paid SKU. I think when you look at the appendix slides, we included a breakout of free versus paid, as Jeff said, for the first time and you can see we had really strong performance in the paid SKU. So I think it shows that, that obviously, a portion of that had to come from TurboTax as well given the size that they are in the marketplace. So I think it was across the board from our perspective.

Scott Schneeberger: Yes, I mean, very, very strong in both. Tony, do you have a sense of the IRS data shared in the DIY category. I think it grew 2.7%. Do you have an estimate of what of that is paid versus what of that is free?

Tony Bowen: We don’t for the category, Scott. I mean, all we know is our data. I mean, we are pleased to see that. Obviously, the paid number grew so much and grew more than the overall category. We obviously know that free is a big part of the growth in the category and to see that our paid number grew almost double what the category a little bit more than what the category grew in total. I think it’s a really good sign that we just delivered a really solid year in DIY.

Scott Schneeberger: I appreciate that. And then curious on your comments and also in your section of the press release, the timing of the marketing and all we’re seeing is the quarter here. So I’m just curious what — was that a pull forward? Was it a pushback on the marketing? If you could elaborate on that a little bit.

Tony Bowen: Yes. It was — last year, we did more in Q3. So this year, more of it’s going to show up in Q4. So I don’t think we think there’s going to be much of a change for a full year basis. So it is just timing of shifting from Q3 to Q4.

Scott Schneeberger: Okay. But it was 3 and 4. Okay. Well, with the new structure, I guess, that captures different.

Operator: Our next question comes from the line of Alex Paris of Barrington Research.

Alex Paris: Congrats on a strong quarter. I got a couple of clarification sort of questions. You had said in prepared comments that the company-owned operations outperformed the franchise operations and I can see that in the appendix as well and attributing the relatively worse position in franchise due to franchise repurchases. But was that the only thing? Or are there other things? Any other color there would be helpful.

Tony Bowen: Yes. Alex, thanks for the question. Yes, most of that — almost all of that difference in performance is due to franchise buybacks. So I think we highlighted that, the revenue growth was driven by company-owned volumes, not necessarily relative outperformance versus franchise. So it’s a little bit of left pocket to right pocket as we’ve talked about in the past.

Alex Paris: Okay. Got you. And then you’ve said a couple of times now, both in the prepared comments and in questions that the DIY outperformance versus the category. A lot of it came from TurboTax and you could see that because they’re uploading previous year returns. On the assisted side, the underperformance down 1.2% in volume versus up 1.2% for the category is, where are you losing market share? In assisted, I mean.

Jeff Jones: Yes. Alex, it’s Jeff. Thank you. At this stage of the year, we don’t know where our business is going to. Like we do every year, we’ll have a sense once we file for the freedom of information report this fall. So I don’t know where. But as I alluded to, we’re down, call it, 130,000 clients year-over-year in our own performance. The number of clients that came to our offices, started tax prep and didn’t finish tax prep is significant, hundreds of thousands of clients. And so that’s really what I’m focused on now is how do we solve some of these experienced breaks that are keeping people who are choosing us from actually converting.

Alex Paris: Great. That’s very helpful. I appreciate that additional color. And I’m sure this is a de minimis thing but just following up on the news story that you had a tax day outage in your downloaded software business. You had indicated, at least in a press article that there maybe was 2,000 inquiries out of 20 million who filed through H&R Block during tax season. Obviously, that has been resolved at this point? And what is the likely impact on H&R Block and on its fourth quarter results.

Jeff Jones: Yes, I appreciate that question. I mean, obviously, we don’t want to disappoint any single client with a technical outage like that. It was not material to business or results in any way that doesn’t take away from what it might have felt like to that client. But we had it resolved in a couple of hours that day and it was more of an inconvenience in filing as opposed to an inability to file.

Alex Paris: Got you. And then the last question kind of along in the same vein, the IRS put out a press release that they hit their goal of 100,000 filers in their direct file product. Just wondering if you have any thoughts there. I think it was only offered in 12 pilot states.

Jeff Jones: Yes, absolutely. No, that’s — we’ve seen the same thing. What they reported, we also know we had very strong DIY paid growth performance. And our stand on direct file really hasn’t changed. We know that there are over 30 organizations that already offer free tax prep and we think it’s a solution in search of a problem.

Alex Paris: Well, I’ll take the other questions offline.

Operator: Our next question comes from the line of George Tong of Goldman Sachs.

George Tong: Just a quick follow-up question. And this is related to some of the questions on TurboTax but they’ve stated that they’re increasingly focused on the assisted category. I guess, over the past tax season, have you noticed any changes in competitive behaviors or competitive dynamics from TurboTax in the assisted category.

Jeff Jones: George, obviously, we don’t know how they performed this year. We’ll hear more in a couple of weeks but I’ve seen no signs that what they’re doing is impacting our assisted business. I think the only thing we saw different competitively this year was they were very promotional and sweep stakes driven. So I guess we’ll see what those promotions and sweep stakes may have done. But — our — what we really saw that impacted our own assisted performance this year was in our own shop of not doing a great job of converting.

Operator: Next question comes from the line of Scott Schneeberger of Oppenheimer & Company.

Scott Schneeberger: It’s 2 separate questions, some separately. The first one, Jeff, you cited — you mentioned some reasons of the assisted filers not completing, didn’t demonstrate expertise. It sounds like execution there and didn’t manage expectations, that could be anything, tax credit that created some confusion this year. Could you address if you think that had anything to do with that second point? And of those, how much of this — I guess what I’m getting at is, how much of it is execution, what you can control? And how much of it is maybe other competitors promoting something that you simply are not going to offer.

Jeff Jones: Yes, a very good question. I’m going to simplify it and say it is execution but let me give you a couple of examples of what I saw too often. So imagine the marketing team drives a new client to the office. They sit down for tax prep. And new client doesn’t know how to do business with us. They don’t understand how the process works. They don’t know how long it will take. They don’t know what it will cost. So the breakdown in execution is around managing expectations, how it’s going to work, make sure we’re always delivering upfront transparent pricing and that’s about the new client experience. We’ve been successful in getting them to the building but we haven’t done a good job of teaching them how to work with us.

I think that’s 1 category of examples. Another category of examples is really in the clients that are working with us virtually. So whether that’s completely virtually or exchanging documents with a tax pro, we just saw too many times this year that we weren’t responsive enough. A client would wonder the status of their return. They weren’t getting e-mails quick enough to let them know the progress and how things were happening. And so you can imagine you’re not physically together and you’re wondering what’s happening and that’s a breakdown in communication. So I think those are 2 broad categories of examples where, of course, all the newness we had in retail this year certainly could impact our ability to execute. Most of those things are now behind us.

But this is an area where I’m just excited because I see how many people are choosing us and coming to the office and are wanting to do business with us and I know we can do better.

Scott Schneeberger: It’s part of that ending there was a segue to my next question which is the changes in retail. And specifically, my question is, modified tax pro compensation, is that going to have — maybe address a little bit if — I guess, will that have any material financial impact this year? Is it relative to your expectation at the start of the year and now what you’re saying about the guidance for the full year, is it same as it was just in a different structure? Or did it move the needle one way or the other?

Jeff Jones: It’s mainly the same as it was just a different structure and we tested this tax pro comp for a couple of years before we implemented it. And the real goal was to make it more clear about driving revenue growth and more transparent and easier for the tax code to understand but it was one of several changes we made that they had to learn and execute against, so that was really more of the point I was making. Tony, anything you could add?

Tony Bowen: Yes. I mean, you said it but it’s — we expect it to be cost neutral. So it wasn’t a change in how much or how we’re ultimately paying them but it does simplify the program.

Operator: Thank you. I would now like to turn the conference back to Michaella Gallina for closing remarks. Mich [ph]?

Michaella Gallina: Thanks, Latif and thanks everyone for joining us today. We look forward to speaking with you next quarter.

Operator: This concludes today’s conference call. Thank you for participating. You may now disconnect.