H & R Block Inc (HRB) 2013 Q1 法說會逐字稿

Good afternoon.

My name is Tanisha, and I will be your conference operator today.

At this time I would like to welcome everyone to the H&R Block first-quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer session.

(Operator Instructions)

Thank you.

Mr. Derek Drysdale, Vice President of Investor Relations, sir, you may begin.

Thank you, Tanisha.

Good afternoon, everyone, and thank you for joining us to discuss our fiscal first-quarter results.

On the call with me today are Bill Cobb, our President and CEO, and Greg Macfarlane, our CFO.

In conjunction with this call, we have posted today's press release and slide presentation on the Investor Relations website at HRBlock.com.

Some of the figures that we'll discuss today are presented on a non-GAAP basis.

We've reconciled the comparable GAAP and non-GAAP figures in the schedules attached to our press release and in the appendix of today's slide presentation.

Unless otherwise stated, please note that all growth rates discussed today refer to the first quarter of fiscal 2013 compared to the first quarter of fiscal 2012.

Before we begin our prepared remarks, I'd like to remind everyone that this call will include forward-looking statements, as defined under the securities laws.

Such statements are based on current information and Management's expectations as of this date and are not guarantees of future performance.

Forward-looking statements involve certain risks, uncertainties and assumptions that are difficult to predict.

And as a result, our actual outcomes and results could differ materially.

You can learn more about these risks in our Form 10-K for fiscal 2012 and our other SEC filings.

H&R Block undertakes no obligation to publicly update these risk factors or forward-looking statements.

With that, I'll now turn the call over to Bill.

Thank you, Derek, and thanks to everyone for joining us on the call.

I hope all of you had a great Labor Day weekend.

During the second half of fiscal 2012, we completed a thorough review of our organization and made some very difficult decisions to reduce our cost structure and to drive efficiency.

While our off-season results typically don't offer a lot of insight into our performance for the year, given the seasonality of our business, and that most of our revenues and earnings are generated in our fiscal fourth quarter, I'm pleased by the impact our cost-reduction initiatives have had to date.

On an adjusted basis, our net loss from continuing operations improved by 6% to $105 million, primarily due to reduced operating costs.

Greg will take you through our results later on the call, but this quarter's key take-away is that we continue to believe our cost-reduction initiatives will add $85 million to $100 million of pre-tax earnings in fiscal 2013, leading to earnings and margin expansion.

In addition to these initiatives, we've had several recent and positive developments.

First, several weeks ago, we announced a new $1.5 billion five-year committed line of credit agreement.

The new agreement provides us significant financial flexibility and more closely aligns to our business needs.

The prior agreement's net worth covenant and clean-down requirements have been replaced in the new agreement with leverage and interest coverage tests which better align with a consumer services company like ours.

We also recently announced a significant milestone in the Company's history.

Our 200th consecutive quarterly dividend will be paid on October 1 to shareholders of record on September 14.

Since Henry and Richard Block took the Company public 50 years ago, the resiliency and consistency of our business has allowed us to generate substantial free cash flow.

And that has enabled us to continue this dividend streak.

Since 1962, H&R Block has paid a total of $3.5 billion in dividends.

This is a strong testament to our business and I am proud to be affiliated with a Company that has a long tradition of returning capital to shareholders.

We expect to deliver appropriate returns of capital to shareholders for many years to come.

Next, I'm pleased to announced today that we've entered into a new partnership with Sears, which we believe will be slightly accretive to fiscal 2013 earnings.

Under the new agreement we've elected to reduce the number of Sears locations in which we operate in, to focus on 112 of our best-performing Sears locations.

The agreement also allows us to open seasonal offices in other Sears locations throughout the country during peak tax season.

In the Sears locations where we'll no longer operate, we believe we'll retain the vast majority of our clients based on our historical experience.

In fact, since 2008, we've exited more than 200 Sears locations and we retained nearly 75% of the clients served in these locations.

To put this in perspective, our retention of all Sears clients last year was 76%.

So we do not expect this agreement will have a material impact on the number of returns we prepare going forward.

That said we're very pleased to maintain our longstanding relationship with Sears and we believe the new agreement benefits both parties and our clients.

We also recently completed our first tax season in both India and Brazil.

Our primary objective was to establish a presence in both of these markets, and our preliminary results are encouraging.

While India and Brazil won't move the needle on our operating results or materially impact our capital allocation in the near future, both remain long-term growth plays.

In the coming months, we'll continue to review our businesses in both markets and plan to make prudent investments focused on profitable and sustainable growth.

And, finally, representation- and warranty-related claim activity at Sand Canyon declined significantly during the first quarter, although we expect claim activity will continue to vary considerably from quarter to quarter, as related statute of limitations continue to expire.

The accrual for representation- and warranty-related liabilities remained essentially unchanged at $129 million.

Turning to our core business, we're working very hard on our plans for successful tax seasons in fiscal 2013 and beyond.

It's been a really busy summer and I'm pleased with the progress we're making.

We still have a lot of work to do but I'm confident that we'll take advantage of the opportunities that lie ahead.

For competitive reasons I won't provide details now.

But I look forward to seeing many of you at our investor conference in New York on December 6, and we'll share our plans with you at that time.

With that, I'll now turn the call over to Greg to discuss our financial results.

Thanks, Bill, and good afternoon, everybody.

Earlier today, we reported our adjusted net loss from continuing operations improved by 6% to $105 million, primarily due to reduction in labor, occupancy and other expenses, driven by our cost-reduction initiatives.

Our GAAP net loss per share from continuing operations of $0.38 was negatively impacted by $0.03 due to fewer shares outstanding in the current year and $0.01 by discrete adjustments to income tax reserves.

We remain on pace with our cost-reduction targets, which we expect will add $85 million to $100 million of pre-tax earnings in fiscal 2013.

Given the seasonality of our business, most of the savings we expect to realize from these initiatives will be back-end loaded during our fiscal third and fourth quarters.

We expect approximately two-thirds of the savings to come from lower labor and occupancy costs, with the remainder coming from other expense categories.

The total savings in fiscal 2013 should be relatively evenly distributed between cost of services and SG&A.

It's important to note that the total pre-tax savings of $85 million to $100 million excludes any potential impact of variable expense growth, which should be reasonably in line with revenue growth.

Ultimately we believe we're well positioned to expand earnings and margins in fiscal 2013.

We'll continue to update you on these cost initiatives throughout the year.

Turning to our segment results.

Tax services revenues were down 1% to $90 million.

Last year the Canadian tax season was extended by two extra days which contributed $4 million of additional revenue in the first quarter of fiscal 2012.

The segment's adjusted pretax loss improved by $9 million or 6% to $144 million, primarily due to a reduction in labor, occupancy costs and other expenses, driven by our cost initiatives.

In corporate, our pre-tax loss improved by 9% to $28 million.

Corporate operating expenses declined by approximately $6 million or 14%, primarily due to our cost-reduction initiatives and lower loss provisions on mortgage loans held for investment at H&R Block Bank.

Corporate revenues declined $3 million due in part to lower interest income from H&R Block Bank's shrinking mortgage loan portfolio.

As we look at our overall financial position our balance sheet and liquidity remain strong.

As of July 31, total unrestricted cash was $940 million.

And total outstanding debt was $1 billion.

Reductions in cash from the prior quarter principally reflect our normal off-season operating cash requirements, and the repurchase of 21.3 million shares at an aggregate price of $350 million, or $14.82 per share.

At July 31, 2012, 271 million shares were outstanding, compared to 306 million shares outstanding at July 31, 2011.

Our first-quarter effective tax rate of 37.6% was down 300 basis points to the prior year.

The lower effective tax rate was primarily driven by discrete adjustments to income tax reserves.

Excluding discrete tax items, we continue to expect our effective tax rate from continuing operations will be approximately 39% in fiscal 2013.

Turning to discontinued operations, which include last year's results of RSM McGladrey, as well as Sand Canyon, our first-quarter net loss of $2 million improved by $54 million, largely due to a non-cash impairment charge recorded in the prior year in connection with the sale of RSM.

Sand Canyon received new claims for alleged breaches of representation and warranties in the principal amount of $142 million during the first quarter.

Sand Canyon completed a review of prior claims during the quarter, with an approximate principal balance of $527 million.

At quarter end, total claims of $260 million remained under review.

Sand Canyon had equity of $265 million at July 31 and its accrual for representation- and warranty-related liabilities remained essentially unchanged at $129 million.

Before I conclude, I'd like to thank all of you who took time to meet with us during our road shows earlier this summer.

It was a pleasure getting to know many of you and I look forward to spending more time with you in the future and continuing our dialogue.

During my first 90 days on the job, I focused most of my attention on our strategic plan, reviewing our capital structure, and assessing each of our businesses to identify ways we can grow and create value.

One of my first priorities was to finalize our new committed line of credit agreement.

We were very pleased with the terms of our new agreement and importantly, we delivered on our promise to have these negotiations completed this summer.

We believe this agreement provides all the financial flexibility a consumer services company such as ours needs and further demonstrates the competence our banking partners have in our business.

With the CLOC negotiations behind us, we are now working to refinance our $600 million notes maturing in January.

As many of you are aware, there is very strong demand for the debt of companies such as ours.

H&R Block is a well-known seasoned issuer with ready access to the market and we are currently a detailed discussions with banks to complete refinancing by year-end.

And, finally, I know many of you are interested in learning more about our capital structure.

At this point, it would be premature for us to provide any details, as we're continuing to review the appropriate structure.

We plan on sharing more details with you in December.

I'll now turn the call back over to Bill for closing remarks.

Thanks, Greg.

In conclusion, I'm very pleased with the progress we've made so far this year.

We're on pace to achieve our cost reduction targets and we're finalizing our plans for the upcoming tax season.

As next tax season quickly approaches, we continue to like our competitive position.

We look forward to sharing our plans and outlook with you at our investor conference in New York on December 6.

With that, we're now ready for questions.

Operator?

(Operator Instructions) Thomas Allen with Morgan Stanley.

One of your competitors talked about outsourcing their prepaid debit card business because the profitability was worse than expected because of new regulations.

Can you just talk about the Emerald card and how new regulations are impacting your earnings there?

Thanks.

How the regulations are affecting our earnings, is that the question?

Yes.

On the Emerald card.

I think, Greg, I'll just say something and then I'll let you potentially.

We are very committed to the Emerald card.

We think it's a great source of growth for us.

We think it's a great service to our clients.

We are one of the largest issuers in the country of general purpose reloadable cards.

We issued almost 3 million last year, loaded almost $10 billion in deposits.

So we are very committed to not only continuing to grow our Emerald cards, but managing it very appropriately.

And then I'll turn it over to you Greg in terms of any earnings impact.

Yes.

Our view is that, currently we have a very successful program.

It's a Top 3 program in terms of the number of cards issued.

And if you look at the amount of money that's loaded onto that, it's quite a substantial program.

As we develop our detailed plan here for this upcoming tax year, we're very bullish on the opportunity that that program represents for us.

Specific to regulations, we're obviously very aware of the things we need to be in compliance with and we always use that as a starting point.

But our goal is to deliver a product to our clients that meets their needs.

And we always strive to do better than that.

Our current products, in terms of the rate structure, the fee structure, disclosures, it's actually award-winning from many of the consumer groups that we've showed it to.

I'm not specifically aware of the regulatory issues that maybe our competitors are facing.

But from our perspective we think it's a great program and we feel really good about its position.

So you wouldn't expect any decline in margins in that business next year?

No.

We're not really giving forward-looking forecasts at this point in time.

Nor do we break out margin by line item like that.

But I wouldn't anticipate anything.

But, like I said, we'll give a fuller review of our entire plans in December.

Okay.

And can you give us the losses associated with the Sand Canyon claims reviewed this quarter?

I think you used to in the past.

I just didn't see it this quarter.

In the quarter, the validity rate was about 4.5%.

As you well know, we review each putback on a loan-by-loan basis.

We, under our contract, or contracts, I should say, have a prescribed time in which to do that.

And we're always diligent about doing that.

And then once we've reviewed that, the claim, which we just gave you the validity rate, we then figure out the actual payment date, how much that is.

Is there more that you're looking for?

The 4.5% validity rate is fine.

I was looking for a number but that's fine.

And then just in terms of, I know you said you're going to give more color on net capital allocation strategy in December.

But can you just say, have you bought back any stock quarter to date?

Just for modeling reasons, should we not expect any buybacks until maybe you've renegotiated the January '13 maturity?

Thanks.

Year-to-date we've bought back $315 million worth of stock.

I think it's 21.3 million shares specifically.

And then with regard to going forward, we are not going to get into when and how much we're going to purchase.

Obviously we have an authorization from our Board and obviously during my time here, we bought back almost 12% of the shares of the stock.

So I would rather you judge us by our actions.

But we're not going to commit to any time frame or say when we are or aren't going to look at stock buybacks.

As you know, we're continuing to protect the dividend as we have for the last 50 years.

Okay, that's helpful, thank you.

Scott Schneeberger with Oppenheimer.

I'll go around the horn a little bit.

On the tax front, with the Sears reduction could you guys give us perspective how many Sears stores you had been in?

And then outside of just across retailers, remind us where you are with Walmart and who else you may have relationships with.

And then, finally, on this question, just your long-term strategy of being in retailers.

Thank you.

I'll take Walmart first.

Walmart, last year we were in about 250 stores.

And while we're not ready to disclose the exact number, we're in discussions with Walmart right now, we will have an increase in the number of locations for fiscal '13.

With regard to Sears, we were in about 500 Sears locations last year.

We will be in 112 Sears stores.

They were our highest-volume, highest-profitability stores.

We will continue to maintain a presence there.

We also have the opportunity in under 100 mall locations to also have a presence there.

So they're in some ways additive where we're working on leases and the like.

But like I said, with regard to our ability to retain clients, which ultimately it is about client retention, we are confident that we've done this before and we know how to do that.

And, in effect, we were able to save money by reducing our footprint.

And yet the win-win for us, in addition to the partnership with Sears, is that we're able to reduce costs on some of our less profitable stores, yet keep our best and brightest.

Okay, thanks for that.

Going to just capital structure, as I break you guys into tax capital structure and putbacks capital structure, and the credit facility versus commercial paper.

Can you give us what your preference is to use during this off season?

And compare and contrast this year as to how soon you might tap into working capital borrowing in this off season.

Thanks.

I think between the lines, you're saying congratulations on getting the CLOC renewed, Scott?

Was that right?

I think I heard that somewhere.

You bet, that's implied.

Nice job.

I do want to spend a minute on that because it was a lot of work.

It's a big number.

A lot of the people here at H&R Block worked quite hard to get there.

And that was really the first step for us.

So I don't want to lose sight of that because the CLOC historically has been our back-up liquidity source.

And getting that taken care of at, I think, very favorable rates -- and there's lots of details in the disclosure so you can read through that -- was a big accomplishment.

And it was also done in the timeline which we outlined pretty much consistently with you, which I think is also worth noting.

Specific to utilization of commercial paper, that has been the traditional source of primary liquidity during the slow season.

The slow season is typically three, four months of the year.

That's, generally speaking, what we look at for the next season, in terms of maybe, also between the lines, going forward, that's all tied up in how we may go forward with our capital structure solution, which, as I said before, we're not really prepared to get into right now and we'll share more details with you in December on that.

Okay, thanks.

And then just I want to touch on the validity again on mortgage putbacks.

That's a very low number, the 4.5%.

Could you just give us a feel for how that's trended over the past few quarters, years?

And just speak to the most recent batch coming in.

I know you haven't looked at it but any additional color you care to share, that's an open question.

Thanks so much.

Yes, Scott, in terms of the new [batch], if you're referring to the $142 million that came in, in the first quarter of new putbacks, we don't comment on that in the quarter.

Our validity rate at 4.5% has continued to decline over time.

The 4.5% validity rate is pretty consistent with the last few quarters.

I don't have the chart in front of me right now but that's in line with what we've been seeing over the last three or four quarters.

So that would be a more consistent pattern right now.

Okay, great.

Thanks guys.

Mike Turner with Compass Point.

A follow-up -- I don't know, Bill or Greg -- just on the financial products.

I know one of your competitors will be more aggressively advertising a RAL product.

Is there any new products that you might have this year to combat that, or other new products?

And then, also, on the Emerald card, I know in the past there were some thoughts maybe to expand the usage of that, to get clients to use it outside of tax season.

Could there be a greater push to find other avenues in retailers?

Are there any schemes there or plans to develop those products?

Let me take those and, Greg, if you want to join in.

With regard to competitors with RALs, et cetera, we anticipate that some of them may offer RALs through non-bank lenders.

To the extent that they offer RALs, any competitors, we think they are going to be only on a limited basis and to a narrow segment of consumers.

So we don't look for this to be a big initiative.

Obviously we'll continue to evaluate the market, respond to our clients' needs.

But at this point, I would anticipate a similar season, that relatively low impact from RALs.

With regard to Emerald card, stay tuned but I think we do have Susan Ehrlich and her team in Financial Services are hard at work at driving not only increased number of cards but increased card usage.

So I wouldn't comment specifically on retailer partnerships but look for us.

That will be a stated objective of ours to increase that.

And the best way for you to get realtime examples of what functionality we have in the card is to get one for yourself and all of your friends and family, too, please.

There already have been over the summer some enhancements to that product.

And that's just the beginning of a very methodical plan that Susan and the team have developed and we look forward to sharing that with more detail in December.

Great, thanks.

And another question that probably comes up all the time, or every year you probably get asked.

Is there any ability to relook at your offices and maybe try and find some cost saves on a seasonal basis?

I know it's hard to close them in the off season, or at least shut them down and find other uses for them.

But is that something that you beat that dead horse or is there a new playbook you're willing to brush off?

The footprint is something that we look at on a continuous basis.

That now reports into Greg's group.

And so we will not only look at, are we sized appropriately with our 10,000-plus touch points in the retail business.

We're very pleased with the mix we have between Company and our partners, our franchisees.

So, at this point, it's one of those things where we decided to reduce by about 200 branches this year.

We decided to take the initiative with Sears.

We're actually expanding in Walmart.

So it's something that's very dynamic and a process that we look at.

We're looking really to just optimize on a continuous basis.

Whether we would do anything on seasonal, et cetera, I wouldn't say we have any plans in place for that, but obviously anything is on the table.

The great thing about having somebody like Greg here is he brings some fresh eyes to a very experienced team that looks at it.

So we're having a good dialogue on that.

But I think it's consistent with what we've been doing.

I don't know if you have anything to add.

After 90 days, the only major conclusion I've got is the word optimize that Bill used is the right word.

I don't think it's the right thing for the Company to dramatically move one direction or another.

They've got a great retail footprint.

They have a very good understanding of the economics behind that.

And for us to bring more rigor and more analysis to that, is probably what we're focused on.

But to me that just results in more optimization than any substantial changes.

Okay, great.

Thanks a lot.

(Operator Instructions) Michael Millman with Millman Research.

Starting from the back, I think in the past, you always said that Walmart was your least profitable tax preparation business.

Maybe you can talk a little bit about why that may change.

Secondly, can you give us some ideas as to why, or what your ideas have been as to why the free RAC didn't work last year.

Competition?

Was it poorly done?

Market doesn't care?

Other reasons?

And thirdly, historically, your predecessors always taught us that you can show optimism for the season by increased losses in the first quarter.

And it looks like in fact your first quarter, when you make all of the adjustments, was flattish, maybe it was down, but certainly the loss wasn't higher.

Thank you.

Let me take the free RAC.

I think, just to be clear on free RAC, it was a success in the sense that we got a lot more Emerald cards into people's hands.

We got a lot more deposits on the free RAC.

I don't think it was a financial success because it was really an attachment product.

It wasn't a traffic-driving product, is in simple form why we believe we shouldn't repeat it.

But it did have some benefits and it also gave us a competitive entry during the last year of RALs.

As far as losses in Q1, Greg?

Yes.

Obviously, Mike, I can't comment historically what the management team was communicating.

I'm just not aware of the details.

But in our first quarter, we gave you the quick variance.

But the one thing I was watching for very carefully was did we, in terms of the actual numbers, see the benefits of Project Runway come through.

So when you look at line item by line item, natural expense account by natural expense account, headcount, cost, compensation of benefits, the real estate footprint, some of the IT costs, did we actually see it come through?

And we did.

And that's why we've reinforced the $85 million to $100 million.

We know at a macro level, a project management level, it's executing.

We also can see it in the financials.

So you get that benefit because we shared that plan with you before.

Implicit, I would guess, in your comment is the ramping up of investment, getting ready for the next season.

I would say that my observation is that there is a very specific plan that we've got that we're working through, coming out of last tax season.

We spent a lot of this summer talking in detail about what that looks like.

We're now executing that.

We're not giving any guidance here, but we feel really pretty good about going into the season, about a lot of things that are underway.

And we'll share more details with you in December.

And there was also the Walmart question.

Could you repeat the Walmart question, Mike?

I'm sorry.

In the past, you've said that the Walmart business was your least profitable business, the least profitable tax business.

So maybe you can talk about what things you may be doing to increase the profit, or if there's some other reasons to be in it.

Promotion, for example.

Yes.

I think the biggest reason why we want to expand this year was we found it as a great source of new clients for us last year.

And that's really what our focus would be.

I think we managed our expenses very well.

We don't disclose specific channel profitability.

But I think that you can look at our expansion with Walmart as really a drive to pick up a growth in new clients.

That would be, to me, the strategic rationale for the expansion in Walmart.

Okay, thank you.

Amanda Lyman with Goldman Sachs.

I was just hoping that you could give us a reminder on what exactly you believe the statute of limitations to be that is affecting the Sand Canyon loans, to give us some perspective on how those '05, '06, '07 vintages might be affected.

Is it five, six, seven years?

And then just going back to the validity rate just one more time.

I think, historically, that validity rate had been as high as, I want to say, in the teens percentage range.

So what is the driver of the decline in the validity rate?

Is it simply that you are seeing claims that you don't believe were as strong as those that were submitted earlier in the cycle?

And if that is the case, is that due to behavior on the trustee side?

Or just any color would be helpful from that end.

Thanks.

Okay, I'll take a shot at it, and then, Greg, if you want to add anything.

First of all, with regard to statute of limitations.

The stated answer is for a contractual claim, to enforce a rep and warranty obligation, is generally six years.

It can be shorter, depending on the law of the state where the event occurs.

Sand Canyon, I believe, that the limitations period runs from the applicable closing date of the sale loan.

And, frankly, there's limited case law on this issue.

But generally, in our conversations that Sand Canyon has had with counterparties, it's generally believed that six years is the proper way to look at this.

With regard to validity rate, I believe the first putback back in 2008 was the highest validity rate at 15%.

That validity rate has come down over the last 4.5 years to where it's generally been the last few quarters, as I said earlier, in the 4%, 4.5% range.

Now, Sand Canyon does not comment on why we think -- because, again, back to what Greg said earlier, Sand Canyon's approach is Sand Canyon no longer originates mortgages, Sand Canyon no longer services mortgages.

So if there are valid, or belief that there are valid claims, then we, Sand Canyon, will review, loan file by loan file, and make a determination.

There's not a stated objective.

It's done on a loan file by loan file basis.

And obviously we report out from Sand Canyon what the validity rate happens to be.

And it has been in that range.

Speculation as to why the quality has declined in terms of valid putback claims, I probably wouldn't speculate at this point.

Because, as I said, we'll go, if you will, $150,000 mortgage at a time and see what the particular issue is there.

I don't know if you have anything to add, Greg.

No.

That's great.

Thank you.

Operator, any other questions?

There are no further questions at this time.

All right, everyone, thank you for joining us.

We appreciate your time.

And please follow-up with us at Investor Relations if you have any follow-up questions.

Thank you and have a good night.

This does conclude today's conference call.

You may now disconnect.