H&R Block, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended April 30, 2016. Although the request identifies 2015 Q4, this is an annual Form 10-K for FY2016; quarterly figures are noted below where useful.
Business context
H&R Block provides assisted and do-it-yourself tax preparation, related products, and financial services, primarily in the U.S., Canada, and Australia. It reports one continuing-operations segment. The business is highly seasonal, with most revenue and cash generation occurring January through April.
Financial performance and liquidity
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Revenue | $3.038 billion | $3.079 billion | Down 1.3% |
| Pretax income | $569.5 million | $742.8 million | Down 23.3% |
| Net income from continuing operations | $383.6 million | $486.7 million | Down 21.2% |
| Net income | $374.3 million | $473.7 million | Down 21.0% |
| Diluted EPS from continuing operations | $1.53 | $1.75 | Down 12.6% |
| Operating cash flow | $532.4 million | $626.6 million | Down $94.2 million |
| EBITDA from continuing operations | $812.2 million | $948.5 million | Down 14.4% |
- Pretax margin was 18.7%, versus 24.1% in FY2015. Adjusted EBITDA was $838.7 million, down 11.8%; adjusted EBITDA margin was 28%, versus 31%.
- Revenue was pressured by fewer assisted returns, foreign exchange, and the bank divestiture; pricing, mix, and acquired franchise businesses partly offset the decline. Total worldwide returns fell 4.1% to 23.2 million; U.S. returns fell to 19.7 million from 20.6 million.
- Operating expenses increased 5.3% to $2.405 billion. Higher occupancy, marketing, depreciation, and other costs more than offset lower compensation expense.
- Cash and cash equivalents were $896.8 million at year-end, down from $2.007 billion. Long-term debt, including current maturities, was $1.503 billion; the $2.0 billion revolving credit facility had no borrowings outstanding, with approximately $1.2 billion then available under its covenant limits. Stockholders’ equity fell to $23.1 million, substantially reflecting the large share repurchase.
- Net cash used in financing was $1.962 billion, principally reflecting $2.018 billion of share repurchases, dividends, and bank-deposit transfers, partly offset by new debt. Investing cash flow was positive $329.5 million, principally due to $436.5 million of securities sales. Capital expenditures were $99.9 million.
- Quarter ended April 30, 2016: revenue was $2.297 billion, pretax income $1.141 billion, and net income $700.7 million, compared with $2.301 billion, $1.210 billion, and $738.8 million, respectively, in the prior-year quarter.
Material changes and unusual items
- H&R Block completed the sale and transfer of H&R Block Bank’s assets and liabilities, including deposits, to BofI on August 31, 2015. It paid BofI $419 million and ceased to be subject to bank and savings-and-loan-holding-company regulation. BofI now offers certain branded financial products distributed by H&R Block; the company’s participation agreement requires it to buy a 90% interest in eligible Emerald Advance balances.
- The bank transaction and related reporting changes reduced reported FY2016 revenue by approximately $29 million. Management estimated the operational and financial effects of the divestiture reduced pretax income by approximately $35 million versus FY2015. Interest income previously classified as revenue was prospectively presented as other income from September 1, 2015.
- The company issued $650 million of 4.125% notes due 2020 and $350 million of 5.250% notes due 2025. Interest expense increased 52.4% to $69.0 million.
- H&R Block repurchased and retired 56.4 million shares for $2.0 billion, averaging $35.46 per share, under a new $3.5 billion authorization. It paid $0.80 per share in dividends for the year.
- Discontinued mortgage operations generated a $9.3 million net loss. Sand Canyon Corporation’s accrued liability for mortgage representation-and-warranty claims was $65.3 million at year-end; additional indemnification and contribution exposures were not accrued because a loss was not deemed probable or reasonably estimable.
Outlook, commentary, and risks
Management stated that, absent unexpected developments, existing capital and liquidity sources were sufficient for future operating and financing needs. It expected future franchisee acquisitions to continue at levels below FY2015 and FY2016. The filing provides no specific revenue, earnings, or cash-flow guidance.
- Key operating risks include intense assisted and DIY competition, free tax-preparation offerings, declining client volumes, and the possibility of government-provided or pre-populated tax filing.
- Seasonality creates off-season liquidity, staffing, and peak-season operating demands. The company also depends on timely tax-software launches and key service providers, including BofI and payment-processing vendors.
- Cybersecurity incidents, identity-refund fraud, privacy violations, or information-system outages could disrupt service, damage the brand, and lead to litigation or regulatory action.
- Regulatory uncertainty includes consumer financial-product rules and potential effects on prepaid cards, arbitration provisions, credit products, and refund transfers. The company disclosed a California Attorney General inquiry regarding refund transfers; FY2016 RT revenue was $165.2 million.
- Legacy mortgage claims remain a material uncertainty. SCC’s estimated liability may prove inadequate, while certain indemnification or contribution claims have no recorded accrual and cannot be reasonably estimated. The filing notes possible attempts to pursue H&R Block directly for SCC obligations.
- Other considerations include $112 million of gross unrecognized tax benefits, foreign-exchange exposure, and contractual obligations of $2.679 billion, including $680.8 million of operating lease commitments.
Investor verification priorities
- Reconcile annual results with the requested period: this filing covers the year ended April 30, 2016, while the filing’s fourth-quarter data show lower revenue and net income than the comparable quarter.
- Assess whether falling return counts, franchise acquisitions, pricing, and DIY monetization can stabilize revenue and margins.
- Review the bank-sale agreements and BofI economics, including fees, guarantees, and the required Emerald Advance participation.
- Evaluate leverage, debt covenants, seasonal liquidity needs, and the effect of the $2.0 billion buyback on equity and future capital flexibility.
- Monitor SCC’s $65.3 million reserve and unaccrued indemnification/contribution exposures, as well as continuing litigation and tax uncertainties.