H&R Block, Inc. — Q1 FY2016 Form 10-Q
Reporting period: Three months ended July 31, 2015. Amounts below are in U.S. dollars; financial statement amounts originally reported in thousands are shown in millions unless stated otherwise.
Business context and reporting period
H&R Block provides assisted and digital tax preparation and related financial products. Results are highly seasonal: peak revenues generally occur January through April, and interim results are not indicative of full-year performance. The quarter’s results include continuing operations and separately reported discontinued mortgage operations.
Key financial results
| Metric | Q1 FY2016 | Q1 FY2015 |
|---|---|---|
| Revenue | $137.7 million | $133.6 million |
| Operating expenses | $311.7 million | $294.9 million |
| Loss from continuing operations before tax | $187.1 million | $175.8 million |
| Net loss from continuing operations | $96.5 million | $108.9 million |
| Net loss, including discontinued operations | $99.7 million | $116.2 million |
| Diluted loss per share | $0.36 | $0.42 |
| Operating cash flow | $(378.2) million | $(381.6) million |
Revenue increased 3.1%, while operating expenses rose 5.7%; the reported operating loss was approximately $174.0 million, or about 126% of revenue. The smaller net loss primarily reflects a higher income tax benefit and lower discontinued-operations losses. A $20.6 million discrete tax benefit, principally related to a Missouri law change, contributed to the current-quarter tax benefit. Adjusted EBITDA from continuing operations, a non-GAAP measure, was a loss of $137.3 million versus a loss of $126.2 million.
Tax Services revenue rose to $132.6 million from $129.1 million, but its pretax loss widened to $169.4 million from $150.6 million. Higher Peace of Mind plan and royalty revenue helped; foreign exchange reduced international tax-preparation revenue. Segment expenses increased, notably occupancy, depreciation and amortization, and other costs including consulting and processing fees. Corporate pretax loss improved to $17.7 million from $25.3 million, partly due to lower borrowing interest expense.
Cash and cash equivalents were $1.30 billion at July 31, 2015, down from $2.01 billion at April 30, 2015. Current assets were $2.11 billion and current liabilities $1.19 billion. Total debt was approximately $506.0 million, principally long-term debt. Cash used in financing was $350.7 million, including $268.5 million of net customer deposit outflows and $55.1 million of dividends paid. Investing activities provided $32.1 million, compared with $26.3 million used in the prior-year quarter.
Material changes and subsequent events
- Compared with the prior-year quarter, revenue increased modestly but expenses grew faster. Operating cash use was broadly flat; investing cash flow improved as acquisitions and capital spending declined.
- After quarter-end, on August 31, 2015, H&R Block completed the sale and transfer of specified bank assets and liabilities, including HRB Bank deposit liabilities, to BofI Federal Bank. H&R Block paid approximately $419 million, approximately equal to the carrying value of liabilities assumed, and intended to liquidate approximately $404 million of bank-held available-for-sale securities. The company also ceased to be subject to the stated bank and savings-and-loan-holding-company regulatory regimes.
- On September 1, the board approved a $3.5 billion share repurchase program through June 2019. On September 2, the company commenced a tender offer for up to $1.5 billion of shares at $32.25–$37.00 per share. The planned tender depended on, among other conditions, closing a new committed credit line. The company also intended to incur incremental debt; completion and terms depended on financing conditions and other factors.
Outlook, risks and unusual items
- Management said existing liquidity sources and anticipated sources under the planned capital structure were expected to meet operating and financing needs absent unexpected developments. The company typically uses cash and short-term borrowing to fund off-season needs.
- Management stated that the seasonal first-quarter pretax loss was expected to be offset by fourth-quarter income under the company’s historical pattern. No specific full-year revenue or earnings guidance was provided in the supplied filing text.
- Discontinued mortgage operations had a $149.8 million accrued liability for representation-and-warranty claims, unchanged during the quarter. Management’s estimate is judgmental and sensitive to legal developments and settlement assumptions. Other indemnification claims may be material, but the company had not concluded that losses were probable or reasonably estimable.
- Litigation accruals totaled $9.3 million. The company said the aggregate reasonably possible losses above accrued amounts for specified matters were not material, while noting that some exposures could not be estimated and unfavorable outcomes could materially affect results. A settlement reached after quarter-end in the FHLB-Chicago matter was covered by prior accruals.
- Unrecognized tax benefits were $76.5 million; management believed they could decline by about $15 million within twelve months. The filing also noted foreign-currency exposure, contingent franchise lending commitments, and that repurchase plans and new financing were not assured.
- Disclosure controls were assessed as effective, and no material changes in internal control were reported. The filing reported no material changes in risk factors or market risks from the prior annual report.
Most important facts for investors to verify
- Whether the planned credit facility and incremental debt were completed on acceptable terms, and the tender offer and broader repurchase program’s actual size, price, and funding.
- The post-sale economics of the BofI arrangements, including H&R Block’s ongoing service obligations and guarantees for branded financial products.
- Seasonal tax-season revenue, expense trends, and the extent to which first-quarter losses are offset in the fourth quarter.
- Changes to the $149.8 million mortgage representation-and-warranty accrual and developments in unaccrued indemnification claims or other litigation.
- Cash, debt, and liquidity after the bank transaction, securities liquidation, and any subsequent capital actions.