H&R Block, Inc. — Q1 FY2017 Form 10-Q
Reporting period: Three months ended July 31, 2016. H&R Block provides assisted and DIY tax preparation and related financial products. Results are highly seasonal; peak revenue typically occurs January through April, so this quarter is not indicative of full-year results. Amounts below are in millions of dollars except per-share data.
Financial performance and liquidity
| Metric | Q1 FY2017 | Q1 FY2016 |
|---|---|---|
| Revenue | $125.2 | $137.7 |
| Operating expenses | $309.9 | $311.7 |
| Loss from continuing operations before tax | $(203.5) | $(187.1) |
| Net loss from continuing operations | $(121.0) | $(96.5) |
| Net loss, including discontinued operations | $(123.7) | $(99.7) |
| Diluted loss per share | $(0.56) | $(0.36) |
| Cash used in operating activities | $(475.7) | $(378.2) |
Revenue declined 9.1%. The operating shortfall—operating expenses exceeding revenue—was $184.7 million, versus $174.0 million a year earlier. Interest expense rose to $21.5 million from $8.6 million, chiefly reflecting $1.0 billion of Senior Notes issued in September 2015. Adjusted EBITDA from continuing operations, a non-GAAP measure, was a loss of $140.0 million versus a loss of $137.3 million.
At July 31, cash and cash equivalents were $306.9 million, with an additional $122.0 million restricted. Long-term debt was $1.492 billion; stockholders’ equity was deficient by $199.8 million. The company had no balance outstanding on its $2.0 billion revolving credit facility at quarter-end; covenant limitations left approximately $1.3 billion available. It borrowed $50 million under the facility on August 31 for seasonal working capital. The company reported compliance with facility covenants at July 31. The filing says existing capital sources were sufficient for operating and financing needs absent unexpected developments.
Cash declined $589.9 million during the quarter, ending at $306.9 million. Financing uses included $48.5 million of dividends and $45.3 million for repurchases and shares surrendered. The declared dividend was $0.22 per share. Restricted cash increased, and the company cited settlement payments on mortgage representation-and-warranty claims as drivers of higher operating cash use.
Material changes versus prior year
- Revenue fell $12.5 million (9.1%). U.S. assisted tax-preparation fees declined 6.8%, primarily due to lower return volumes, partly offset by improved rate and mix. International revenue fell 4.2%, and Emerald Card revenue fell 16.7%.
- Operating expenses decreased only $1.8 million (0.6%). Occupancy and equipment costs increased $4.6 million, while other expenses decreased $5.1 million.
- Net loss widened by $24.0 million, and diluted loss per share increased from $0.36 to $0.56. The weighted-average share count fell to 220.5 million from 275.8 million, primarily due to repurchases in the prior and current years.
- Cash used in operations increased by $97.4 million. Investing cash inflow declined to $5.1 million from $32.1 million; financing cash outflow improved to $117.0 million from $350.7 million, primarily reflecting the prior-year change in customer banking deposits.
- Compared with July 2015, cash and cash equivalents were lower ($306.9 million versus $1.299 billion), and long-term debt was higher ($1.492 billion versus $502.0 million). Customer banking deposits were nil versus $476.7 million.
Outlook, risks and unusual items
- No specific revenue, earnings or cash-flow guidance is provided. Management emphasizes the seasonal cash needs of the business, typically funded with cash from tax season and borrowings during the May–December off-season.
- The discontinued mortgage business had a $25.5 million accrued liability for representation-and-warranty claims at July 31, down from $65.3 million at April 30, after $40.0 million of payments. The company said the payments under settlements entered during the quarter were covered by prior accruals. Estimates depend on management judgment and may change.
- Potential indemnification or contribution claims related to mortgage securitizations were not accrued because the company had not concluded losses were probable or reasonably estimable; it could not estimate a possible loss range for these claims. The filing warns unfavorable outcomes could be substantial. SCC’s principal assets were approximately $347 million, primarily an intercompany note receivable.
- Other litigation accruals were $2.3 million. The company stated that the aggregate reasonably possible losses in excess of accruals for certain matters were not material, while noting some exposures could not be estimated and outcomes are uncertain.
- Gross unrecognized tax benefits were $106.0 million. Management believed they could decrease by approximately $13.9 million within 12 months; $7.5 million was expected to be cash-settled in that period.
- Credit-facility covenants include maximum debt-to-EBITDA and minimum interest-coverage ratios. Ratings were Moody’s Baa3 with stable outlook and S&P BBB with negative outlook at July 31. The company reported no material changes in risk factors, market risk, contractual obligations or regulatory environment from its latest Form 10-K.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether peak-season tax-preparation volumes and pricing/mix recover enough to offset the Q1 revenue decline.
- Cash needs through the off-season, use of the revolving facility, covenant headroom and the effect of the August $50 million draw.
- Debt-service burden following the 2015 Senior Notes issuance and the implications of the negative S&P outlook.
- Developments in discontinued-mortgage representation-and-warranty claims, related settlements and unaccrued indemnification exposures.
- Progress under the $3.5 billion repurchase authorization and sustainability of dividends, given the quarter’s operating cash use and stockholders’ equity deficiency.