H&R Block, Inc. — Q1 FY2014 Form 10-Q
Reporting period: Three months ended July 31, 2013; filed September 5, 2013. The unaudited quarter is seasonally weak: H&R Block’s peak tax-preparation revenues are generally earned January through April, so interim results are not indicative of full-year performance. Unless noted otherwise, amounts below are in U.S. dollars.
Financial results and key metrics
| Metric | Q1 FY2014 | Q1 FY2013 |
|---|---|---|
| Revenue | $127.2 million | $96.5 million |
| Operating loss | $179.6 million | $172.4 million |
| Continuing-operations pretax loss | $184.5 million | $169.3 million |
| Net loss | $115.2 million | $107.4 million |
| Diluted loss per share | $0.42 | $0.39 |
| Operating cash flow | $(318.7) million | $(373.1) million |
| Cash and cash equivalents at quarter end | $1,163.9 million | $939.9 million |
| Total debt, current and long-term | $906.6 million | $1,009.6 million |
- Revenue increased 31.8%; the company attributed most of the increase to the timing of Australian early-season tax revenue, which it expected to largely reverse by the end of Australia’s tax season in October.
- Operating margin was approximately negative 141% versus negative 179% a year earlier; net margin was approximately negative 91% versus negative 111%. Margins are calculated from reported revenue and loss.
- Net cash decreased $583.7 million during the quarter, to $1,163.9 million. Investing used $29.1 million and financing used $229.3 million. Financing outflows included $179.4 million of net customer deposit withdrawals and $54.6 million of dividends paid.
- Cash used in operations improved by $54.4 million year over year, primarily because HRB Bank had lower restricted-cash requirements. Property and equipment purchases increased to $34.4 million from $13.3 million, primarily for tax-office upgrades.
- Quarter-end current assets were $1,704.9 million and current liabilities were $1,450.5 million. These include customer banking deposits and restricted cash; the company said its available liquidity sources were sufficient for operating needs and anticipated obligations absent unexpected developments.
Changes, drivers and management commentary
- Continuing-operations pretax loss worsened 9.0%. Management cited $7.5 million of professional-adviser fees and accrued employee termination benefits related to the proposed bank transaction, and a $2.9 million write-down on mortgage loans transferred to held-for-sale. Lower interest expense was offset by foreign-currency losses, higher litigation costs and increased other loss reserves.
- Tax Services revenue rose to $121.7 million from $90.3 million, while the segment’s pretax loss widened to $144.4 million from $140.9 million. International tax-preparation fees rose mainly because of Australian revenue timing; Emerald Card fees increased with higher transaction volumes.
- Interest expense fell to $14.4 million from $22.1 million, principally due to lower rates on senior notes and lower principal balances. The mortgage-loan loss provision increased to $7.6 million from $4.0 million.
- H&R Block reported non-GAAP adjusted EBITDA from continuing operations of negative $138.7 million, compared with negative $129.2 million. The measure excludes specified items, including transaction-related fees and selected litigation and severance items.
- The company paid a $0.20-per-share dividend, unchanged year over year. It reported no open-market share repurchases in the quarter; remaining authorization was $857.5 million.
Outlook, transaction, risks and contingencies
- Bank transaction: HRB Bank and Block Financial agreed to transfer HRB Bank’s deposit liabilities to Republic Bank, with a corresponding cash payment, subject to regulatory approval and completion of additional operating agreements. The deposit liabilities would have been $759.7 million at July 31. Management said additional regulatory processing time was needed and expected to continue offering financial products through HRB Bank for the 2014 tax season. The company could not predict whether or when the transaction would close.
- Completion would result in HRB Bank merging into Block Financial and surrendering its bank charter, potentially ending H&R Block’s savings-and-loan-holding-company status and related Federal Reserve oversight. The company was negotiating agreements for Republic Bank to provide branded financial products while H&R Block services and administers them.
- Capital and liquidity: The company said it had no commercial-paper or committed-line borrowings outstanding at July 31 and cited a $1.5 billion unsecured committed line of credit. Basel III rules were scheduled to apply beginning January 1, 2015, subject to phase-in. Management warned that capital rules could constrain dividends, share repurchases, acquisitions and other capital-allocation decisions. Moody’s and S&P debt outlooks were negative.
- Discontinued mortgage exposures: Sand Canyon Corporation had accrued $158.8 million for representation-and-warranty claims and estimated reasonably possible additional losses of up to $30 million. It received $68.6 million of new claims during the quarter and was discussing potential bulk settlements; management noted that estimates are judgmental and may change. Mortgage loans held for investment totaled $309.7 million, with a 4.8% allowance; approximately 59% of the portfolio was concentrated in Florida, California, New York and Wisconsin.
- Other litigation: Accrued litigation liabilities were $12.5 million. The estimated aggregate reasonably possible loss in excess of accruals was $0–$56 million, approximately 52% relating to discontinued operations. Some matters could not be reasonably estimated; the company cautioned that unfavorable outcomes could be material in the period recorded.
- Tax matters: After quarter end, the IRS notified the company that reviews for tax years 2008–2010 and remaining refund claims for 1999–2007 had been approved at the required administrative levels. The company anticipated approximately $100 million in cash, with an insignificant tax-expense impact.
- No formal full-year earnings or revenue guidance is provided in the supplied filing text. Management emphasized seasonality and risks from regulatory approvals, litigation, credit losses, foreign-currency movements and the timing of Australian revenues.
Most important facts for investors to verify
- Whether Republic Bank transaction approvals and the required marketing and receivables agreements are completed, and how the transition affects financial-product revenue, costs and regulatory status.
- Whether Australian tax-season timing reverses as expected and how full-season Tax Services performance compares with the prior year.
- Developments in Sand Canyon mortgage claims, bulk-settlement discussions, litigation accruals and the potential losses beyond recorded reserves.
- Whether the expected approximately $100 million IRS-related cash receipt is received, and the timing and use of those funds.
- Liquidity and capital-allocation capacity under Basel III and Federal Reserve oversight, including the sustainability of dividends and any future repurchases.
- Credit quality and loss trends in mortgage, credit-card and franchisee receivables, including the geographic concentration of the mortgage portfolio.