H&R BLOCK INC quarterly report, Q2 FY2016

H&R Block, Inc. — Q2 FY2016 Form 10-Q

Reporting period: Three and six months ended October 31, 2015. H&R Block provides tax preparation and related services and products through offices and digital channels. Results are highly seasonal, with most revenue and cash flow generated from January through April; interim losses are therefore not indicative of full-year results.

Financial performance and liquidity

Metric	Three months ended Oct. 31, 2015	Six months ended Oct. 31, 2015
Revenue	$128.4 million, down 4.6%	$266.1 million, down 0.8%
Operating expenses	$362.2 million, up 13.5%	$673.9 million, up 9.8%
Net loss from continuing operations	$142.5 million; $0.54 per share	$239.0 million; $0.88 per share
Consolidated net loss	$145.0 million; $0.55 per share	$244.7 million; $0.90 per share
Adjusted EBITDA from continuing operations (non-GAAP)	$(168.8) million	$(306.1) million

Cash flow: Six-month operating cash use was $602.7 million, compared with $627.6 million a year earlier. Investing activities provided $365.1 million, largely reflecting proceeds from securities sales; financing activities used $1.398 billion. Cash and cash equivalents ended at $360.7 million, down from $627.5 million at October 31, 2014.
Balance sheet and debt: Total assets were $2.290 billion and total liabilities $2.317 billion, leaving a $27.2 million stockholders’ equity deficiency. Long-term debt was $1.502 billion. Current assets were $726.7 million and current liabilities $566.5 million.
Capital returns and liquidity: The company paid $110.3 million in dividends during the six months and repurchased 40.5 million shares for $1.5 billion at $37 per share. It had no borrowings under its new $2.0 billion revolving credit facility at October 31 and said existing liquidity sources were sufficient for operating and financing needs absent unexpected developments.

Material changes versus the prior comparable period

Quarterly revenue fell $6.2 million, mainly because foreign-exchange movements reduced reported international revenue; management said international revenue was flat to slightly higher in local currency. For the six-month period, lower international revenue was partly offset by higher off-season tax-return volumes and Peace of Mind plan revenue.
Operating expenses rose $43.2 million in the quarter and $59.9 million year to date. Increases reflected higher occupancy and depreciation/amortization costs associated mainly with acquisitions and office improvements, plus professional fees related to the capital restructuring and bank divestiture and other operating costs.
Quarterly continuing-operations net loss increased by $29.3 million. Six-month continuing-operations net loss increased by $16.9 million. The six-month period also included $10.9 million of other income, primarily realized gains on securities formerly held by HRB Bank.
On August 31, 2015, H&R Block completed the sale and transfer of HRB Bank’s deposits and certain assets and liabilities to BofI, making a net cash payment of approximately $419 million. The bank ceased to exist, and the company and its holding companies ceased to be subject to the related bank and savings-and-loan-holding-company regulatory regimes.
In September, the company issued $650 million of 4.125% senior notes due 2020 and $350 million of 5.250% notes due 2025, and established a new $2.0 billion revolving credit facility. Debt ratings were Moody’s Baa3 (stable) and S&P BBB (stable); Moody’s ratings had declined from Baa2 at April 30, 2015.

Outlook, risks, contingencies, and unusual items

The filing provides no numerical full-year revenue or earnings guidance. Management emphasized seasonality and stated that off-season operating losses require cash and may be funded from prior-season balances and short-term borrowing.
The new credit facility includes debt-to-EBITDA and interest-coverage covenants, along with other restrictions. The company reported compliance and no facility borrowings as of October 31, 2015.
Discontinued mortgage operations had a $153.8 million accrued liability for estimated representation-and-warranty losses, up from $149.8 million at the start of the six-month period. The company said additional losses could vary from estimates; certain indemnification and contribution claims were not accrued because loss probability or amount could not be determined. An unfavorable outcome could be material.
Other litigation liabilities accrued were $6.2 million. The company reported that the reasonably possible losses in excess of accruals for matters it could estimate were not material, while noting that some exposures could not be estimated. It intends to defend the claims.
Unrecognized tax benefits were $96.6 million; the company said approximately $14.5 million could decrease within the next 12 months. A $26.6 million discrete tax benefit contributed to the six-month tax results, primarily due to a Missouri law change.
Unusual items included $20.8 million of professional fees related to the bank divestiture and recapitalization in the six-month period, partly offset in reported results by gains on securities sales. Management’s non-GAAP adjusted measures exclude specified items and should not be treated as GAAP results.

Investor verification points

Track seasonal tax-season volumes, pricing, digital adoption, and the effect of foreign exchange on international revenue.
Assess whether operating expense growth moderates and whether acquisitions and office investments generate expected returns.
Review cash needs, revolver availability and covenant headroom following the large repurchase and increased debt.
Monitor the financial and operational effects of the BofI arrangements, including the company’s continuing role in marketing, servicing, and supporting branded financial products.
Follow developments in discontinued mortgage litigation and indemnification claims, and compare ultimate payments with the $153.8 million accrued estimate.
Evaluate the sustainability of dividends and further repurchases against seasonal cash requirements and leverage.