H&R Block, Inc. — Q2 FY2017 Form 10-Q
Reporting period: Quarter and six months ended October 31, 2016. Unaudited results; amounts below are in USD millions unless stated otherwise. H&R Block provides assisted and do-it-yourself tax preparation and related financial products. Its business is highly seasonal, with peak revenue typically from January through April; interim losses are therefore not indicative of full-year results.
Financial results
| Metric | Three months ended Oct. 31, 2016 | Prior year | Six months ended Oct. 31, 2016 | Prior year |
|---|---|---|---|---|
| Revenue | $131.3 | $128.4 | $256.5 | $266.1 |
| Net loss from continuing operations | $(143.4) | $(142.5) | $(264.4) | $(239.0) |
| Net loss, including discontinued operations | $(146.2) | $(145.0) | $(269.9) | $(244.7) |
| Consolidated loss per share | $(0.68) | $(0.55) | $(1.24) | $(0.90) |
- Revenue and costs: Quarterly revenue rose 2.3%, while six-month revenue fell 3.6%. Six-month operating expenses declined 3.7% to $649.3 million, but higher interest expense and lower revenue contributed to a larger continuing-operations loss. The filing does not present a conventional positive operating margin; operating expenses exceeded revenue.
- Cash flow: Six-month operating cash use was $725.8 million, versus $602.7 million a year earlier. Investing activities used $55.8 million, compared with $365.1 million provided in the prior period; financing provided $121.4 million, versus $1.398 billion used. Cash and cash equivalents ended at $232.5 million, down from $896.8 million at April 30, 2016. Restricted cash was another $109.5 million.
- Debt and liquidity: Long-term debt and line-of-credit borrowings totaled $1.967 billion, plus $0.9 million current debt. The company had drawn $475 million on its $2.0 billion unsecured revolving credit facility; covenant limits left approximately $948 million available to borrow. It reported compliance with facility covenants. Total stockholders’ equity was a deficit of $557.5 million.
- Dividends and repurchases: Dividends declared were $0.44 per share for the six months. The company repurchased and retired 9.6 million shares for $217.0 million at an average $22.51 per share, lowering weighted-average shares substantially from the prior-year period.
Material changes and management commentary
- Six-month U.S. assisted tax-preparation fees decreased 4.6%, primarily from lower return volumes, partly offset by improved rate and mix. U.S. DIY fees declined 9.7%. International revenue increased 2.2%, with foreign exchange cited as a contributor. Peace of Mind plan revenue increased 5.7%; Emerald Card revenue decreased 14.9%.
- Interest expense increased $21.3 million for the six months, primarily reflecting $1.0 billion of Senior Notes issued in September 2015. Prior-year results included gains on available-for-sale securities and costs related to the HRB Bank divestiture and capital-structure changes; mortgage and investment income presentation also changed, affecting revenue and other-income comparisons.
- Management said existing capital sources were sufficient for operating and financing needs absent unexpected developments. It gave no specific full-year earnings or revenue guidance in the supplied filing text.
- The Board approved a plan to sell the mortgage-loan portfolio. The company expected to close in December 2016 and receive approximately $190 million for the portfolio and real estate owned, based on indicative bids, with proceeds intended for general corporate purposes.
- For the 2017 tax season, H&R Block planned interest-free Refund Advance loans for eligible assisted clients. Third parties initially committed $1.45 billion of funding capacity, subsequently increased to $1.65 billion. H&R Block expected average origination fees of $32–$36 per funded loan and provided limited guarantees of up to $73 million, subject to thresholds.
- New CFPB prepaid-product rules take effect October 1, 2017, with some provisions phased in. They apply to the Emerald Card, Emerald Advance and Refund Advance products; the company was assessing their impact.
Risks, contingencies and unusual items
- Discontinued mortgage subsidiary Sand Canyon Corporation had a $25.5 million accrual for representation-and-warranty claims, down from $65.3 million at the start of the six-month period after $40 million of payments. The company said possible losses beyond accrued amounts were not material based on its current estimate, but noted that actual outcomes could differ and certain indemnification or contribution claims could not be reasonably estimated.
- Mortgage-related litigation includes Homeward claims; in one case, a court allowed claims involving additional loans, and SCC’s reconsideration and appeal-related motions remained pending. The filing describes potential exposure, including attempts to assert claims against H&R Block, but does not quantify all possible losses.
- The company reported $2.3 million of accrued liabilities for other matters and stated that aggregate reasonably possible losses above accruals were not material for matters it could estimate. It warned unfavorable litigation outcomes could nevertheless be material.
- The company’s seasonal operating cash needs, significant debt, covenant limits, and dependence on the upcoming tax season are important liquidity considerations. Management’s liquidity statement is qualified by the possibility of unexpected developments.
Important facts for investors to verify
- Whether the mortgage-portfolio sale closed on the expected terms and generated the anticipated approximately $190 million in proceeds.
- Tax-season return volumes, pricing and product adoption, particularly given lower assisted and DIY revenue in the six-month comparison.
- Available borrowing capacity and covenant compliance as seasonal cash needs rise; note that reported facility availability was approximately $948 million, not the full undrawn facility commitment.
- Refund Advance loan funding, actual participation and fee economics, and any calls under the $73 million limited guarantees.
- Developments in Sand Canyon representation-and-warranty litigation and indemnification claims, including whether exposures change materially from the recorded accrual.
- The operational and financial effects of the CFPB prepaid-product rules and any changes to dividends or share repurchases.