H&R Block, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended April 30, 2018 (including fourth quarter). The request metadata says “2017 Q4,” but the supplied filing is the annual report for FY2018; figures below follow the filing period.
Business context
H&R Block provides assisted and do-it-yourself tax preparation, related services and financial products, principally in the U.S., Canada and Australia. It operates as one reportable segment. The business is highly seasonal: most revenue and cash flow occur from February through April, and the company generally incurs losses during the first three fiscal quarters.
Financial results and liquidity
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $3.160 billion | $3.036 billion |
| Income from continuing operations before taxes | $668.7 million | $629.3 million |
| Net income from continuing operations | $626.9 million | $420.9 million |
| Net income, including discontinued operations | $613.1 million | $408.9 million |
| Diluted EPS, continuing operations | $2.98 | $1.96 |
| Operating cash flow | $850.0 million | $552.2 million |
| EBITDA from continuing operations (non-GAAP) | $941.4 million | $904.4 million |
| EBITDA margin (non-GAAP) | 29.8% | 29.8% |
Revenue rose 4.1%; operating expenses increased 3.8% to $2.408 billion. Pretax margin improved to 21.2% from 20.7%. The effective tax rate fell to 6.3% from 33.1%, primarily reflecting the U.S. corporate rate reduction from 35% to 21% under the Tax Cuts and Jobs Act, magnified by the company’s seasonality and mismatch between tax and financial reporting years. The unusually low FY2018 rate materially boosted earnings; it should not be treated as a normalized rate.
At April 30, 2018, cash and cash equivalents were $1.545 billion (plus $118.7 million restricted), total assets were $3.141 billion, and stockholders’ equity was $393.7 million, versus a $60.9 million deficit a year earlier. Long-term debt, including current portion, was approximately $1.496 billion. The company had no balance outstanding on its $2.0 billion revolving credit facility; covenant-limited borrowing availability was approximately $1.7 billion, and it reported covenant compliance. The filing states existing liquidity sources are expected to meet operating and financing needs absent unexpected developments.
Capital expenditures were $98.6 million; dividends paid totaled $200.5 million ($0.96 per share). Investing cash flow was an outflow of $112.1 million, while financing cash flow was an outflow of $190.7 million. Cash increased $546.1 million during the year.
Changes versus the prior year
- Worldwide returns prepared increased 1.5% to 23.3 million; U.S. returns increased 2.5% to 20.0 million. Paid U.S. DIY returns rose 7.8%, while assisted returns declined 0.6%.
- U.S. assisted preparation revenue rose 2.4%, U.S. DIY revenue rose 11.0%, international revenue rose 8.1%, and Refund Transfer revenue rose 16.0%. U.S. franchise royalties declined 1.9%.
- Higher wages, occupancy costs and bad-debt provision contributed to operating expense growth; bad-debt provision rose 41.1% to $74.5 million. Lower marketing spend partly offset increases.
- Operating cash flow rose by $297.8 million, attributed mainly to higher net income, lower taxes paid and prior-year mortgage-claim settlement payments. Investing cash flow shifted from an inflow to an outflow, principally because the prior year included mortgage-loan portfolio sales.
- Cash repurchases of common stock were minimal in FY2018 compared with $322.9 million in FY2017. FY2018 share purchases disclosed in the fourth-quarter table were employee tax-withholding shares, not purchases under the public program.
Outlook, risks and unusual items
- Management expected a FY2019 effective tax rate of 23%–25%, subject to operating results, discrete items, interpretations of the new tax law and other factors.
- The company expected to review its pricing structure in response to individual tax-law changes and said the changes were expected to negatively affect FY2019 revenue. A higher standard deduction and fewer itemized deductions may reduce demand for tax preparation or affect pricing.
- Management described an ongoing comprehensive strategy review. Implementing resulting objectives is expected to require investment and could weigh on near-term financial results; execution and anticipated long-term benefits are uncertain.
- H&R Block decided to close approximately 400 tax offices after the 2018 season, recording a $7.4 million write-off. It expected another $15–$20 million of expense in FY2019 to exit related leases.
- Key risks include intense competition and free filing options, cybersecurity and protection of sensitive taxpayer data, seasonal workforce and operational demands, vendor reliance, regulatory changes to financial products, and potential effects of tax simplification. The CFPB Payday Rule’s future and impact on Emerald Advance remained uncertain; the prepaid-card rule was delayed to April 2019, with no material impact expected by management.
- Discontinued mortgage subsidiary Sand Canyon Corporation (SCC) remains exposed to mortgage representation-and-warranty, indemnification and contribution claims. No liability was accrued for the described claims because losses were not considered probable; material payments could nevertheless adversely affect the company. SCC-related suits involve 21 notified lawsuits and 39 securitization transactions with about $14 billion in original investments. H&R Block also disclosed limited guarantees in specified circumstances.
- Tax-law accounting estimates were provisional and still under assessment. Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective.
Important facts for investors to verify
- How much of FY2018 earnings growth reflects the temporary tax-rate timing effect, and whether the FY2019 23%–25% tax-rate outlook is achieved.
- Whether tax-law changes and pricing adjustments reduce client demand, revenue per return or margins, especially in assisted and DIY channels.
- Trends in paid DIY growth versus assisted-return declines, franchise volumes and the economics of office closures.
- Bad-debt trends and performance of Refund Transfers, Emerald Advance, Emerald Card and other partner-provided financial products.
- Progress and costs of the strategy review, office lease exits, and continued dividend funding under seasonal cash-flow and debt requirements.
- Developments in SCC litigation and guarantees, CFPB rules, cybersecurity incidents, and the final measurement of Tax Legislation impacts and uncertain tax positions.