H&R Block, Inc. — Q1 FY2018 Form 10-Q
Reporting period: Three months ended July 31, 2017, compared with the three months ended July 31, 2016, unless otherwise noted. Amounts below are in U.S. dollars; financial statement amounts are converted to millions. The quarter is typically an off-season period: peak revenue is generally February through April, so interim results are not indicative of full-year results.
Business context and financial results
H&R Block provides assisted and do-it-yourself tax preparation, related services, and financial products, primarily in the U.S., Canada, and Australia. It reports one continuing-operations segment.
| Metric | Q1 FY2018 | Q1 FY2017 | Change / context |
|---|---|---|---|
| Revenue | $137.8 million | $125.2 million | Up $12.6 million, or 10.1% |
| Operating expenses | $323.0 million | $309.9 million | Up $13.1 million, or 4.2% |
| Loss from continuing operations before tax | $205.2 million | $203.5 million | Loss increased $1.7 million |
| Net loss from continuing operations | $127.8 million | $121.0 million | Loss increased $6.8 million |
| Net loss, including discontinued operations | $130.6 million | $123.7 million | Loss per diluted share was $0.63, versus $0.56 |
| EBITDA from continuing operations (non-GAAP) | $(140.3) million | $(140.8) million | Improved $0.5 million |
| Cash used in operating activities | $409.1 million | $458.0 million | Use of cash decreased $48.8 million |
No operating margin is stated in the filing; the company reported an operating loss of approximately $185.2 million, calculated as revenue less operating expenses. Interest expense was $21.3 million. Dividends declared were $0.24 per share, versus $0.22.
Liquidity, debt, and cash flow
- At July 31, 2017, cash and cash equivalents were $551.6 million and restricted cash was $116.6 million; combined cash and restricted cash totaled $668.2 million. Cash and cash equivalents alone were $1,011.3 million at April 30, 2017.
- Current assets were $833.9 million and current liabilities $562.5 million. Stockholders’ equity was a deficit of $214.3 million.
- Long-term debt, including the current portion, was approximately $1.494 billion, primarily senior notes. The company had no balance outstanding on its $2.0 billion revolving credit facility; covenant-limited borrowing availability was approximately $1.6 billion. It reported compliance with facility covenants.
- Investing activities used $13.0 million, including $13.1 million of capital expenditures; financing activities used $27.5 million. Dividends paid were $49.9 million. Operating cash use reflected the seasonal business cycle and working-capital movements.
Material changes and management commentary
- Revenue growth reflected higher U.S. assisted tax preparation fees (+17.8%), Peace of Mind service plan revenue (+18.2%), and Emerald Card revenue (+14.7%). International revenue rose 4.0%; Refund Transfer revenue declined 12.9%.
- Management attributed higher costs mainly to wages, rent and equipment, depreciation and amortization, and other expenses. Other income fell $1.4 million, principally because the prior-year period included income from the mortgage loan portfolio that had since been sold.
- Operating cash use was lower than the prior-year period, primarily because the prior year included settlement payments relating to mortgage representation-and-warranty claims. Investing cash flow also compared unfavorably because the prior year included mortgage portfolio proceeds.
- Management said existing capital sources were sufficient for operating, investing, and financing needs absent unexpected developments, and expected to continue paying dividends, while noting there is no assurance dividends will continue. No specific earnings or revenue guidance is provided in this filing.
Risks, contingencies, and unusual items
- Legacy discontinued mortgage operations remain a material uncertainty. The company described litigation and indemnification or contribution claims connected with past mortgage securitizations; outcomes and potential losses may be difficult to estimate. It had $1.7 million accrued for the matters discussed in the litigation note and said the estimated aggregate reasonably possible loss above accruals was not material, while some exposures could not be estimated. The representation-and-warranty liability was $4.5 million at July 31, 2017.
- The CFPB issued a rule restricting class-action waivers in pre-dispute arbitration clauses for certain consumer financial products and services. If effective, the company said it could increase class-action litigation risk; the rule could also face legal or congressional challenges.
- Adoption of new stock-based compensation guidance resulted in a discrete tax benefit; the notes report $5.1 million from adoption and a $5.2 million discrete tax benefit for the quarter, primarily related to excess tax benefits on employee stock-option exercises. The filing also adopted guidance requiring restricted cash to be included in cash-flow statement cash reconciliations.
- Gross unrecognized tax benefits were $141.4 million. Management said the balance could decrease by approximately $10.4 million within 12 months, including $4.2 million expected to be cash settled in that period. The 2014 U.S. federal tax return was under examination.
- Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether seasonal tax-season revenue and cash generation support the company’s liquidity and debt covenants through the off-season.
- Drivers and sustainability of revenue growth, especially Peace of Mind plan revenue, assisted preparation volumes, and financial-product fees.
- Developments in legacy mortgage litigation and indemnification claims, including any changes to accruals or estimable loss ranges.
- Whether the CFPB rule takes effect and how it may affect consumer-product offerings and litigation exposure.
- Changes in tax reserves, expected settlements, and the effects of accounting guidance and discrete tax items on reported results.