H & R Block Inc (HRB) 2015 Q3 法說會逐字稿

Good afternoon.

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

At this time I would like to welcome everyone to the third-quarter earnings conference call.

(Operator Instructions)

Thank you.

Thank you, Kevin.

Good afternoon, everyone, and thank you for joining us to discuss our third-quarter fiscal 2015 results.

Joining me on the call today are Bill Cobb, our President and CEO; and Greg Macfarlane, our CFO.

Jason Houseworth, President Global Digital and Product Management; and Mark Ciaramitaro, Vice President Healthcare, will be available during the Q&A session.

In connection with this call, we have posted today's press release 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 reconcile the comparable GAAP and non-GAAP figures in the schedules attached to our press release.

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.

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 2014 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.

Thanks, Colby, and good afternoon, everyone.

Earlier today we announced our results for the fiscal 2015 third quarter, which ended January 31.

The IRS opened e-file earlier this January than it did last year, which allowed us to recognize additional revenue in the third quarter compared to last year's quarter.

Of course, because of the seasonality of our Business, our third-quarter results are not indicative of our expected full-year performance.

Greg will provide more details on our fiscal third quarter later during this call.

As has become the norm in our industry, the tax season is off to an interesting start.

We entered the season with the Affordable Care Act featured prominently in the news.

This soon gave way to market disruptions in the DIY category, due to pricing actions taken by a competitor.

Finally, industry-wide DIY tax fraud, which we have been discussing for some time, became a key focus this season, with our top competitor in the DIY space saying they're seeing as much as a 3,700% increase in DIY fraud related to tax refunds in some states.

I'd like to spend the next several minutes talking about what we've seen in the industry this year, specifically focusing on the Affordable Care Act and fraud, and then I'll provide some thoughts on our performance.

Let's start with the ACA, which represents the largest change to the US tax code in decades.

Our clients are feeling the impact and they have a lot of questions and at times are confused.

Many have been required to complete additional forms or worksheets.

As we released on February 24, our analysis shows that 52% of those that obtained health insurance via the state or federal marketplaces underestimated their annual income and are having their refunds reduced by an average of 17% or $530.

Conversely, roughly a third overestimated their income and are having their refunds increased by $365 on average.

Overall, the average impact has been a refund reduction of 8% or $141.

Our analysis further shows that the penalty for uninsured filers is averaging $172 or almost double the $95 penalty many taxpayers anticipated.

Consumer behavior will likely shift in future years as the penalties for noncompliance continue to climb, motivating more people to purchase insurance through exchanges.

Early data from the Department of Health and Human Services indicates that over 11 million people signed up for healthcare insurance through the exchanges this year, an increase from 7 million enrollees the year before.

This is an area in which we have a great opportunity to assist our clients with their needs and we believe this opportunity will continue to grow over the next several years.

Specific to this tax season, the proportion of our clients who have been directly impacted by the ACA has thus far been lower than our expectations.

We entered this year expecting the ACA to impact the first half of the season at a greater rate, but we are now seeing results that suggest ACA-impacted clients will be more evenly distributed throughout the season and possibly more heavily weighted toward the second half.

This is in part due to the delays in forms mailings by the federal and state exchanges, which is likely pushing filings from the early part of the season to the later part.

In fact, the HHS announced in late February that 90% to 95% of marketplace participants who had received incorrect 1095-A forms had yet to file their taxes.

I'd like to provide one final thought related to the ACA.

I'd be remiss if I didn't mention the tireless efforts of our associates and tax pros who are providing best-in-class service to our clients impacted by these changes.

We've invested over 600,000 hours of ACA-related training for our tax professionals, and it's showing in the quality service we're providing.

Based on our channel checks, we are distinguishing ourselves as the ACA experts in the tax preparation industry.

And while there's still a lot of season left, we're pleased with our efforts to date and we will continue to help our clients navigate the tax complexity introduced by this law.

I'd now like to take some time to talk about an issue that has finally received a lot of attention this season, tax fraud.

As I noted in my open letter published in the New York Times on February 17, fraud in our industry continues to be a significant and growing concern to which no taxpayer is immune.

Government agencies put the total annual tax identity theft losses at greater than $5 billion, with nearly 2 million suspected identity theft incidents in 2013.

That's up from just 440,000 incidents in 2010, which represents an increase of over 350%, or 1.5 million, in just three years.

And what was once an issue focused at the federal level has now extended into the state level, as evidenced by our largest competitor having to shut down their state e-filings during the height of the DIY tax season to evaluate state-level fraud exposure.

Another problem cited by the Treasury Department is improper Earned Income Tax Credit payments, which total $16 billion to $19 billion annually, up from estimates of $13 billion to $15 billion.

Inconsistent EITC return standards have moved the issue out of the assisted tax space and into the DIY channel, contributing to a material change in EITC taxpayer behaviors, which I will discuss later.

Fraud is not a new issue for the industry and H&R Block has been at the forefront of the battle against fraud for years.

We have collaborated with the EITC software development work group at the IRS since early 2013 to develop fraud screening parity between assisted and digital tax prep.

Last year we brought together tax policy and consumer advocate thought leaders at a forum in Washington, DC, to discuss this very problem and to announce the findings of our survey regarding consumer awareness and attitudes toward tax fraud.

I have testified before the Senate Finance Committee and met with numerous members of both the House and Senate regarding EITC and the need for professional standards for tax preparers.

Our efforts are producing results.

Late last year, on December 16, Congress directed the Treasury Department to implement consistent requirements across all tax preparation methods for taxpayers applying for credit such as the EITC.

Now, Treasury needs to implement the requirements in time for tax season 2016, which I'll address shortly.

I have issued a call to action to the IRS and my colleagues within the tax preparation industry to come together to create solutions to these problems.

Recently IRS commissioner Koskinen announced that he will convene a meeting to facilitate this discussion.

There are both long- and short-term solutions to consider, but two immediate actions should be taken to minimize the potential for fraud.

First, there must be minimum federal competency standards for all tax preparers.

As you have heard me say before, all 50 states impose licensing requirements for cutting hair, but currently there are no federal standards on competency applicable to all paid tax preparers and only four states have such standards.

This isn't about simply creating another category of professionals, it's about empowering and protecting the 60% of consumers who get help with their taxes every year.

Second, we need to address the $16 billion to $19 billion of annual improper payments related to the Earned Income Tax Credit.

Having different standards for different methods of tax return preparation is encouraging fraudulent behavior in the DIY channel.

Since 2008 when the inconsistent standards came into play, there has been a 14-point increase in the proportion of EITC filers using do-it-yourself preparation methods, from 28% then to 42% in 2014.

During this same period, the broader market's filing patterns did not change materially.

Considering that 20% of all tax returns include the EITC, a shift of this magnitude has a significant impact on improper payments and the overall industry.

This move from assisted to DIY allows the taxpayer to avoid having to answer up to 27 additional questions on a separate tax form to determine EITC eligibility.

Additionally, assisted tax preparers are now personally liable for properly completing the additional EITC form.

This has resulted in fraudulent tax preparers acting as ghost writers by completing taxes for their clients on a DIY platform without the preparers signing the return.

As I mentioned earlier, on December 16, Congress directed the Treasury Department to implement consistent standards for these credits by saying the following: Quote, in an effort to reduce intentional fraud and filing errors in refundable credit programs intended to help taxpayers, the Department of the Treasury is directed to ensure that the same questions are being asked of taxpayers whether they are preparing their returns with a paid tax preparer or via do-it-yourself methods such as paper forms, preparation software or online preparation tools.

Implementing uniform questions for refundable credit filers is a common sense step that will help alleviate confusion over eligibility and better establish qualifications for these credits, end quote.

That sounds pretty clear to me.

We agree with Congress that this is common sense.

In contrast, the largest competitor in the DIY space has said that consistent standards present taxpayers with a, quote, compliance burden, end quote.

It is both ridiculous and self-serving to suggest that requiring consistent fraud screens to fix a $16 billion to $19 billion problem is too great of a burden to bear.

It is also ridiculous that one group of taxpayers should have to answer a series of up to 27 questions to obtain the credit, while another group is not held to the same standard.

This is crucial to protect the people eligible for the credit and to prevent fraudsters from abusing the system at the expense of those that need it most.

As these consistent standards have yet to be implemented by the Treasury Department, we will continue to advocate for such standards and for Treasury to develop and implement a plan in time for tax season 2016.

As I said earlier, we've been leading the fight against tax fraud for some time.

And it's clear that taxpayers are ready for change, as 93% of those surveyed by H&R Block are willing to do more to help combat fraud.

Additionally, as long as tax fraud is allowed to persist, it will be difficult to get a true read on the overall industry, and as such, its impact on our results.

H&R Block will continue to lead the charge against tax return fraud and I urge my fellow industry leaders to join me in this fight.

Our message has been and is clear, as an industry we need to do the right thing.

Given that industry overview, I'd now like to talk about our early season results.

To be clear, I am disappointed in our first-half assisted volume.

While we do not anticipate fully making up this loss of assisted returns and share in the second half of the season, we have reason to look forward to a stronger second half.

Filing patterns within our client base, as well as changes within the industry, suggest we are seeing a shift in the timing of our business.

Consistent with the past two years, our assisted filers are moving out of the traditional first peak and shifting toward a more delayed filing schedule.

Part of this is likely due to the speed of refund processing by the IRS and state governments.

While it used to take months to receive your refund after filing your taxes, you may now receive your money in as little as eight days.

Additionally, part of this is likely due to delays related to the ACA that I mentioned earlier.

Despite this shift, we continue to experience success in our Tax Plus strategy to drive revenue through improved monetization and product attach.

By focusing on the optimal return mix with strong product attach rates, we are seeing positive financial results, despite a significant decline in assisted unit counts to date.

Unit count is not the sole determinant of success in this industry.

We have learned over the years that giving away our product to drive client count without regard for profitability doesn't work.

There is a significant portion of taxpayers who are solely motivated by cost and, thus, are not loyal.

This means that monetizing these clients in the long run often doesn't happen, no matter which channel, assisted or DIY, they use to prepare their taxes.

In addition to the timing shift, the lower assisted volume stems from our decision to discontinue unprofitable promotions in prior years and the migration to DIY as a result of fraud.

Consistent with last year, assisted return declines have been greater in lower-value returns as we continue to focus our efforts on those returns that contribute most significantly to the bottom line.

Our 50%-off promotion is targeting just those types of returns, as it is designed to attract more complex, higher value returns at a time when our offices historically have had available capacity.

On the digital side, I'm very pleased with all aspects of our business: our product performance, the client experience, our pricing, our marketing campaigns and our results.

Revenues are up and we have increased unit sales from the prior year in both our desktop and online products.

Our multi-year effort to enhance our product and improve the client experience is yielding positive results.

Providing our clients with a fully responsive personalized experience is driving an improvement in client satisfaction, which ultimately translates to the top line.

Online e-files are up 7.2% and desktop is up 5%, as we are benefiting from competitors' pricing decisions and from well-targeted promotions.

Overall unit growth for digital is up 6.7% from last year, and even more importantly, our mix of paid versus free returns has dramatically improved.

Our Tax Plus products continue to provide tremendous value to our clients.

Our newest product, Tax Identity Shield, is an innovative product that offers our clients tax identity theft protection and support.

Given the significant increase in tax identity theft, it is a timely offering that provides our customers the added comfort of knowing that they have protection and support and is an example of H&R Block's innovation and knowledge of the tax industry.

And for the second consecutive year, our Emerald Card has been rated as one of the top three prepaid debit cards in the market by a leading consumer advocacy publication.

To summarize, we've invested more than anyone in this industry in the ACA.

We continue to lead the charge in the fight against tax fraud.

And I believe our value proposition is the best in the industry.

Considering all the factors I've discussed today, we won't have a full understanding of the tax season until after April 15.

The season so far has been challenging, but we have reason to look forward to a stronger second half.

We intend to stay fully focused on serving our clients however they want to be served, whether by coming to our offices to get assistance from our experienced tax professionals, or through our best-in-class digital offerings.

With that, I'll now turn the call over to Greg to discuss the fiscal third-quarter financial results.

Thanks, Bill and good afternoon, everybody.

As a reminder, given the seasonality of our Business, and the fact that the significant majority of our revenue and all of our earnings come in the fourth quarter, our third quarter results generally are not indicative of the results we expect to achieve for the full year.

As Bill mentioned, the IRS opened e-file earlier this year than in 2014.

Because we recognize tax preparation fees when completed returns are filed with the IRS, we recognized an additional 11 days in revenue in the third quarter of fiscal 2015.

Overall, revenues for the quarter were $509 million, representing an increase of $309 million compared to the prior-year quarter.

Net loss from continuing operations was $35 million, or $0.13 per share, compared to a net loss of $213 million, or $0.78 per share, in the prior year.

For the full fiscal year we continue to target adjusted EBITDA margins of approximately 30%.

We continue to maintain a strong balance sheet with excellent liquidity.

Cash and customer banking deposit balances were significantly higher at the end of the third quarter this year due to the earlier funding of refunds by the IRS.

The total unrestricted cash balance was $1.3 billion.

And total outstanding debt was $1.1 billion, which includes $591 million in commercial paper borrowing.

And as a reminder, we repaid a $400 million note in October 2014, leaving us with $500 million in senior notes as of January 31.

Finally, we expect our effective tax rate for fiscal 2015 to be at the lower end of the range provided at our Investor Day in December, of 35.5% to 36.5%.

Turning to our segment results, tax services revenues increased $309 million to $503 million as a result of the earlier e-filing opening date.

Consistent with expectations, total operating expenses increased $62 million to $571 million.

The increase is due to variable costs associated with tax return preparation, expenses related to acquired franchise operations, increased training costs related to both the ACA and our new tax preparation software and increased marketing.

Additionally, depreciation and amortization increased as a result of the franchise buybacks we discussed at our investor conference on December 9. As a reminder, we stated that we were looking to re-acquire a portion of the 650 offices sold to franchisees several years ago.

This fiscal year we repurchased 341 of those locations for approximately $100 million.

In addition, we have spent approximately $12 million in other acquisitions, primarily of independent tax preparers.

Going forward, we will continue to evaluate potential franchise buybacks and independent targets.

However, we do not expect the overall mix of Company-run versus franchise locations to change materially.

We continue to expect depreciation and amortization expenses of $160 million to $170 million for the fiscal year 2015.

Included in this is amortization expense related to these acquisitions of $14 million, with an annualized rate of $19 million for the fiscal year 2016.

In our corporate segment, our pretax loss decreased $10 million to $15 million, mainly due to decreased interest expense as a result of the repayment of the $400 million note in October of 2014.

Reduced legal and consulting fees also contributed to reduction in expenses.

Turning to discontinued operations, the net loss from discontinued operations was $2 million.

During the third quarter, Sand Canyon entered into a settlement agreement with a counterparty related to its representation and warranty obligations.

The settlement amount was fully covered by prior accruals and was paid in the fiscal third quarter.

Sand Canyon's accrual for contingent losses relating to representation and warranty claims totaled $144 million as of January 31.

Sand Canyon continues to engage in constructive settlement discussions with the counterparties from which it has received a significant majority of its asserted claims.

As a reminder, Sand Canyon is, and always has been, operated as a separate legal entity from H&R Block.

We continue to believe our legal position is strong on any potential corporate veil piercing argument.

Lastly, turning to H&R Block Bank, we continue to work with BofI and our regulators and believe that on its merits, this transaction should be approved.

We will continue to provide updates as we make progress.

We've covered a lot on today's call, so we'll now turn it over to your questions.

Operator?

(Operator Instructions)

Your first question comes from the line of Kartik Mehta with Northcoast Research.

Your line is open.

Good afternoon, Greg and Bill.

Hi, Kartik.

If you look at the early season, Bill, is there any reason that you can come up with why maybe your volumes are falling behind the IRS numbers?

Have you come across something that you think is the primary catalyst for this?

As we said, I think in the press release, we do think there's a delay.

The IRS released some numbers earlier today in which the overall industry total returns is down 0.6%.

At this same time last year it was up 1.4%.

You have right there, year on year, a 2 point shift.

We're seeing this certainly in our offices where it seems like clients are coming in later, whether it's form delays or whatever.

The ACA confusion, form delays, form errors has also contributed to this.

I think we have had a carryover effect from a retention spiral from getting away from the free EZ.

We had an impact last year.

I think there is a carryover impact this year.

And frankly, and this is why I spent a long time on this, until EITC filers are generally early season filers, until we get consistent standards, that shift, that migration away from paid preparers with having to answer 27 questions and verify a bunch of information, open season, is going to contribute to that shift.

So I don't have one thing that has contributed to it.

Obviously as I said in my comments, I'm disappointed.

But there is some factors that I think point to, if you will, beyond our control.

But we are working very hard, and I do think we have a lot of reasons to have a positive outlook for the remainder of the season.

I do want to add a caution onto that statement.

I think it's very misleading and difficult and I've shared this with you all before.

I think the unit count numbers can be misunderstood pretty easily.

Mix matters very much in this industry, and so we're very much as much focused on units as we are mix.

Also there's still a lot of season to go here.

So the IRS headline today is three of five filers still have to file for the rest of the year.

Those are my thoughts as well.

And so, I know this is difficult this time around because of what happened last year with the delay in filing, but looking at the revenue miss you talked about last year and trying to normalize revenue this year versus last year, you have been very good about getting pricing and obviously that has -- ancillary products have helped you there.

If I did my math right, it seems like it could be pricing is probably in the high single digits, maybe even low double digits.

Is that accurate?

Would you be able to sustain that type of pricing because of mix and ancillary products going into the rest of the tax season?

So I'm not going to obviously comment on your math, Kartik.

What we had said generally is we know we've got pricing power in this industry, and we would typically say that's somewhere north of the rate of inflation.

There's no reason to not think that's true for us this year.

The other thing specifically for 2015 tax season for 2014, is the implementation of ACA.

So part of our pricing strategy going into this season obviously had to include the value and the costs that we're incurring for our clients to deliver this service, and we're going to charge for that this year.

And so far we've been very pleased at the results there.

Other than that, we're not going to give specific pricing thoughts until, really, post season.

One last question, Bill.

I just want to make sure I heard you correctly in your prepared remarks.

Did you say that because of where you are in terms of client count, it would be difficult to make that up, so therefore, difficult to get the kind of flat or positive client count?

Or do you think that's still possible since we have a significant amount of the tax season still left?

What I said was I think it will be difficult to fully recover that number of clients.

I do think we will -- I think there are a lot of our clients still to come in.

I think that's consistent with what we've seen in the past, where generally we'll start off softer than others in the beginning of the year.

But in terms of whether we are able to crawl all the way back, I don't think we'll be able to do that.

But I think we're going to have a much stronger second half.

Perfect.

Thank you very much.

Thanks, Kartik.

Your next question comes from the line of Gil Luria with Wedbush Securities.

Your line is open.

Thank you.

So what proportion of your customers ended up having to, so far year to date, season to date, have had to either fill out a new form because of the Affordable Care Act?

Or have to move up from a more simple form to a more complicated form because of the changes to healthcare this year?

So I don't think we're, Gil, we're going to give specific numbers on forms, et cetera.

I would say that what Mark had talked about at Investor Day was, we anticipated about 25% of our clients would be impacted.

The numbers we have seen so far indicate that we are under that number at this point in the season.

As Greg just cautioned, I think we've got to wait and see this all play out because of some of the externalities that you heard about.

But in terms of any form shifts, we're not going to get into that right now.

Mark, is there anything you want to add to that?

I will say, as we anticipated, many of our clients and consumers in general are really feeling the full effects of the Affordable Care Act this year.

And we're seeing that obviously have some impact on their filing behavior, we believe.

And they're confronting a new level of complexity.

As Bill mentioned, some of those clients are actually seeing surprises in terms of their refund behavior or their refund effects.

But we've always said this is a long-term proposition.

We believe many clients will be impacted this year.

They're on the learning curve.

Many more clients will be impacted next year, frankly, on the basis of the enrollment numbers we've seen.

So we're going to see the rest of this year play out, but this is really a long-term impact that we're just at the front end of seeing.

And I think we've talked about that before.

I think Greg has continually cautioned against this.

Next year you won't just be able to self attest that you have insurance.

There are changes that are coming.

When you go into something like this where the intersection of something like the Affordable Care Act with taxes seems so counter-intuitive to so many consumers and the awareness is low.

We're seeing a little bit of that play out.

I think as things get more comfortable, there might be more, if you will, normal patterns.

But right now I'm not sure I could predict what a normal pattern is anymore on the assisted side.

So we'll see how this plays out.

And then in terms of fraud, which has really taken off this year.

As you pointed out, it sounds like it's less of an issue for you than some of your competitors.

What are you doing in terms of the specific measures?

Are you introducing multi-factor authentication?

Do you plan to do that?

Do you plan to maintain the bundling of state and federal to prevent state filing-specific fraud?

How are you handling what you're seeing from your competitors in terms of your policies and technology for handling fraud?

I'm going to let Jason get into that.

I would you say one thing, Gil, is that for any CEO this is of paramount importance, the whole area of cyber security.

We're fighting against a number of bad guys here.

This has been of high concern.

I think we've talked about this.

Frankly, I think I said it at Investor Day.

We're a lone voice here.

There are a lot more voices here.

Why don't we talk about the specifics that we do, Jason, if you could take that.

Sure, thanks, Gil.

What I would say first is that Intuit is really late joining this conversation.

We've had a number of fraud filters in place for multiple years.

First, we have multi-factor authentication within our log-in process and that's been in place since 2011.

Our password strength for our online accounts has some of the strongest requirements in the industry.

And we do not allow unlinked returns to be filed to states.

That is to say we actually require an accepted federal e-file before we even send or file the state return.

As we previously indicated, our internal fraud monitoring team has not seen any unusual fraud activity this tax season.

We think that ultimately those points are really key.

I think what happened this year was by not waiting until the federal return was accepted by the IRS, which has the strongest fraud filters, it's hard for any individual state to match the power of the IRS.

That's why we had put this policy in place, that we wanted an accepted return by the IRS before we would file the state.

I think that's where the fraudsters cracked the code.

Got it, thank you.

Your next question comes from the line of Thomas Allen with Morgan Stanley.

Your line is open.

Hi, guys.

At your Investor Day you stated you expected industry assisted volumes to grow 0% to 1% and digital to grow 4% to 5%.

Can you just update us on your thinking now?

Thanks.

Yes, I think we're trying to figure that out, frankly, Thomas.

I do think the digital number, the number that came out today, which will probably fall over time, but it was roughly 6% for the total digital business.

Paper returns according to today's numbers, were down 13%.

Right now assisted is down 4.4%.

That will improve over time.

That's been the history here.

We still believe that the overall industry will grow 1.5%, or in that range.

When you're down 0.6% and you're more than 40% of the way through, you're a little bit questioning that.

But we believe that with the delay, all the stuff that's happened, generally people still have to file in this industry.

And I believe it's going to be a much stronger second half.

Okay.

And then can you just touch on the competitive environment?

You wrote about it in your prepared remarks.

Obviously there's been a lot of talk around pricing adjustments and marketing.

So can you just talk about how you feel the environment is?

Well, it's always very competitive out there.

There's a lot of factors in the industry, obviously on the digital side.

The launch of the free product by Turbo going after the low end, drove the number of filings they had.

I don't know if we ever fully figured out how many of those were due to that and due to fraud.

I think we had a very competitive offering, certainly in the digital phase, with the program Jason put together with the $9.99 program.

Certainly we were really pleased with the marketing there.

We're really pleased with how the new product is working.

On the assisted side there were some things done in terms of some cash give-aways and then add that to the price that were done out there, we're still trying to assess the impact on that.

And some RAL behavior that we'll have to see how that all plays out.

So it's been a highly competitive start to the season, coupled with consumer delays.

So it's a little hard to read and that's why we'll say this 14 more times probably on this call.

We've got to wait and see how everything plays out.

Okay.

And then just a short question on the specifics of your business.

So you guys talked about how you bought a number of franchisees.

But then when we look at your return volumes, your franchisee volumes are better than your Company-owned stores.

Why is that?

The table that we released actually adjusts for that factor in there.

So we've reclassified what would have been franchise last year into Company to make it more apples to apples, Thomas.

Okay.

Well, that explains most of it.

But should we expect the franchisees to outperform the Company-owned stores through the season, after adjusted, or not?

Yes, historically we're pretty close on both.

We have no reason to believe that's not true this year.

Okay.

Thank you.

The next question comes from the line of Jeff Silber with BMO.

Your line is open.

Hey, guys.

It's Henry Chien calling in for Jeff.

I just had a question on the legislation to potentially give the IRS authority to regulate preparers.

Have you heard any progress on that front?

With the recent news of fraud and some of the attention there, has that shifted some of the regulatory momentum to more standardized requirements for DIY versus assisted?

Any comments that you have there.

Thanks.

Here's what I would say.

Obviously you've got two different issues.

The EITC issue, Congress has already directed the Treasury Department to implement the consistent standards.

It's a matter of the Treasury Department doing it.

In terms of return preparer, that has to go the other way, which is Congress has to now initiate that as a law.

We are working hard at that.

I think, frankly, there is a lot of talk.

We're certainly with our government relations team, working very closely with a lot of aspects of government that the tax fraud that has come up here, the amount of dollars that are being doled out and losses and improper payment.

I think that there are certainly a lot more awareness around this, which we hope will add to the effort around finally getting competency standards nationally.

We're not sitting around, we're very active at the federal level.

We're also working at the state level to try to increase the number of states who require competency and licensing.

And importantly this season, two states have now introduced return preparer standards; New York State being the primary one of those.

And there's several other states that we would think are likely to have them in place for next year.

Okay, great, thanks.

And if I could tack one on, on the pricing side.

I know there's been some confusion around ACA forms, but from what you've seen so far, are you seeing, based on your expectations or what you're planning for, are you still seeing any pricing lift from ACA just overall, in general?

Thanks.

So we just as a matter of policy don't talk at form level pricing, it's just not something we do.

Having said that, we did go into this season, spent a lot of time and a lot of money getting our people ready and our systems ready to help our clients through this very difficult transaction.

And we've added value to their lives and we're going to charge for that.

So certainly we've got a pricing strategy around ACA.

It really is going to be dependent on your situation, frankly, what price you'll pay.

It's a bit more complex than just a simple number.

The take-away I would say thus far, is we're actually very pleased with the price-value equation and so are our clients.

Great, thanks so much.

Your next question comes from the line of Scott Schneeberger with Oppenheimer.

Your line is open.

Thank you, good afternoon.

Greg, I'm going to follow on that one.

I know you don't speak specifically on forms, but it sounds like you are pleased with what you're seeing, particularly in mix, I would say, across the board.

Were there any significant rate increases, excluding ACA from the conversation, this year, year over year, on any forms in the store front area?

The way we price is really based on bundle experiences.

And so a bundle would be a typical client experience that covers a large number of people from one year to the next.

So the reason I'm sharing that with you is there will always be, unfortunately, some exceptions where a person's circumstances are so unique that they get caught up in just the way that bundles get priced out.

In general, we have been very thoughtful about price sticker shock.

If someone, for example, went from a 1040-EZ and because they have ACA forms, would automatically have to go to a 1040-A or a 1040 form type.

That was something that we certainly factored in, because we obviously are looking to have a long-term relationship, not a one-year relationship with these clients.

Okay, fair enough.

Bill, one for you.

This is going to be, I think, the first that you mentioned; you're going to get this 13 more times.

And I already know the answer, but I'm asking it nonetheless.

There are multiple reasons that you listed in the press release and then you added on this call, fraud as a potential reason that we saw more DIY as opposed to assisted in the early part of the season.

My question specifically is, of the -- I count five or six reasons that you've put out there vocally or in print.

I know the answer is, it's too early to tell.

But in your personal opinion, what would you rank as the top three ideally in descending order, if possible?

All right, I'll take a shot at it.

I'll answer your answer, and say we've got to wait and see.

However, I do think that the delay, the stats the IRS put out today, and as I said, there clearly appears to be a shift of consumer behavior later in the season.

So when you have a 2-point swing year over year, that certainly speaks to delay.

I think the second piece is, there's really two fraud issues broadly.

There's all the DIY fraud I spoke about earlier.

There's also, with the IRS saying things like their budget cutbacks, they can't do as many audits, we continue to see and as we've been very active in the A&D space, the amount of fraud done by independents is startling.

That's why the return preparer is so important.

Because we think that getting people who have to take a competency exam and be licensed and sign the return is critically important.

And then the third piece, I'd say, is around all the externalities around ACA.

That is not the quantitative answer that you might -- if you just ask my opinion, I would say those are the three.

All right, thanks, I appreciate that.

And that is what I was looking for.

One follow-up on point two that you just mentioned.

You are trailing the IRS, the industry year to date on professionally prepared, and obviously there's a lot of ground to make up.

You just mentioned that you're seeing a lot of fraud in professionally prepared among the mom and pops.

Is that something that you think will be a pressure in the back half, where you may not narrow the gap of yourself and the industry or even turn it to the other side?

Or is that more of an early season phenomenon that will dissipate here in the back half?

Generally, it's been an early -- the history, it's been an early-season impact, but we'll have to wait and see.

A lot of it's surrounding earned income credit filers and they tend to be early-season filers.

Thanks for that.

Then a couple more if I can, going around in other areas.

You put out a press release with regard to Canada looking more aggressive with your do-it-yourself product.

I'm curious, since your strategy last year and continued this year at least in the US, is to pursue revenue.

That's the primary focus and all that entails.

It feels like you're taking almost a counter-strategy in Canada.

Just curious what the thinking is there?

Thanks.

Each country that we operate in has a unique strategy, of course, tied to the overall Company mission here.

But Canada's situation is much different than the US.

There, we had no presence to speak of in the DIY space at all.

Intuit is the largest market participant there and we think that's going to have to change.

We're prepared to be in that for many years to think what we want to do is win our fair share.

And we're prepared to spend the money to get there.

And the follow-up there, it looks like I can't come to any way that you're going to be monetizing with perhaps a cross-sell or anything that strategy this year.

And I think your answer also suggests it's longer term.

Is that true?

It's not a this-year impact, it's more down the line?

The multi-year strategy that we've embarked upon, and we're prepared to, as I said, fund it during that time frame.

But I will just tell you in the grand scheme of thing it's not a material number for most shareholders.

Thanks.

Then batting up cleanup, I want to sneak one or two more in.

The $50 million reduction in the loan loss reserve, and clearly there was some settlement, but clearly there's an existing amount on the loan loss reserve in Sand Canyon, so it's not all settled.

Greg, can you share a little bit more about what occurred, why it wasn't a complete settlement?

It sounds very productive and good.

Kind of curious, why partial.

Just to clarify.

I know you knows this, Scott.

These are reserves for representation and warranty claims, not loan losses, as such.

But in the last quarter, third quarter of this fiscal year, Sand Canyon did enter into a specific settlement agreement with a counterparty and that was fully reserved for in the reserve.

The reserve itself moved down by $50 million, which was a fairly material number and was paid out during that quarter.

So I think that's good progress.

The reserve itself is also supported by other claimants that Sand Canyon is engaged in having productive conversations.

I know that many people would like to get better clarity on the timeline, but the reality is that these are a slow process and it just takes time.

Our words continue to be consistent that there's forward progress being made here.

So getting this one resolved, I think, is an indication that there is progress.

Thank you.

And then lastly, looking to slip it in.

The Bank, really, not much discussed on this call.

I don't know that you're going to share much more.

But is there a level two deeper open question that you care to share with us at this point?

Thanks.

On the Bank transaction?

Yes.

Yes, the transaction that we got with BofI is a good transaction for BofI.

It's a good transaction for H&R Block.

It's been with the regulator now for a year plus.

We believe on the merits and the structure of the transaction will be approved.

For us, we really just have to get it approved and implemented for next tax season.

So we've got a fair amount of time to work with right now.

Obviously, if we can get it approved well before that, that would be excellent, and closed.

Our position remains the same that we think it will be approved and it's really up to this regulator ultimately, though.

Any increase, decrease in communication with regulator?

Anything that you would share outside or --?

Both ourselves and BofI have regular conversations with the regulator in normal course business.

And of course as we have appropriate questions come in as relates to this transaction, we would respond to those as thoroughly and quickly as we can.

We continue to be in a position where we're really just waiting, for the most part at this point, for resolution.

But there's been no change in the frequency or type of questions that we've seen in the last several months.

Okay.

Thanks for taking all my questions.

Thanks, Scott.

Your next question comes from the line of Anj Singh with Credit Suisse.

Your line is open.

Hi, thanks for sneaking me in here.

Just a couple quick questions.

On the competitive dynamics touched upon earlier in your prepared remarks, and not being able to fill that hole in assisted versus the IRS filings, do you have a sense whether these filers have gone to other preparers or are they going to DIY?

Do you have a sense of where they're going to?

Well, the overall assisted business, the latest numbers from the IRS is down 4.5% season to date.

So obviously, the whole area of assisted is suffering.

We're a little worse than that, but there seems to be assisted.

Digital is about in line in terms of their growth rate with what we had talked about.

I have reason to believe that the points I was making in my prepared remarks is that the EITC migration will get higher until Treasury implements the directive from Congress next year.

And the EITC filer on the DIY basis has a free lane.

I think that point shift is going to go higher than 42%.

But we'll have to see how that plays out.

So I think in that sense, yes, there would be a shift.

I think overall, we think when the season is done, the assisted to digital shift will be more in line with what it's been the past couple of seasons, which is primarily due to this EITC issue.

Got it.

And I'm not sure if you touched upon this earlier, but I was wondering if you can comment on some of your strategies this season, enticing users of other preparers or software to switch to Block at half the cost or no cost?

How does this fit with your strategy last year to cut out low-margin filers and what's the response been to these strategies this season?

Well, let me take the assisted side.

And then, Jason, if you want to speak to the promotion we've done with DIY.

I think we had a plan before we started this season that during the mid-February to mid-March time frame, when we generally have available capacity, we wanted to be aggressive with trying to bring in new clients with our 50% off promotion.

We're right in the middle of that right now.

We'll see how that plays out.

That was a considered strategy, really from a capacity basis, and in terms of trying to drive against picking up more clients.

So that was the idea behind the assisted side.

As far as DIY goes, Jason, why don't you talk about the overall integrated plan we put together.

Sure.

First, in desktop we saw an opportunity to give very dissatisfied TurboTax clients the opportunity to try our product.

By doing so, we felt like that they would recognize it's the best value in tax software.

Really we called this Switch to Block, which offered TurboTax clients who sent us a copy of their receipt, free H&R Block deluxe software.

We're very pleased with the response of this.

But more importantly, we're pleased with our desktop share performance in the early season.

We estimate we've taken about 3 points of market share in desktop.

And even though our results to date in e-file is desktop up 5%, our unit sales are up much stronger than that.

Again, this is a really nice high-value client and one that we are actively attracting.

Okay, great.

And one for Greg.

I just wanted to make sure, I wasn't clear on this.

Are there more franchise purchases coming this year?

Or have you bought all the ones that you're expecting to for 2015?

Yes, I think the vast majority of them we completed this season.

There may be some small changes next year, but for the material part we've done in 2015 fiscal year.

Got it.

One final one, if you can answer this I'd appreciate it.

Just wondering, we saw the dates in the merger agreement get revised further out.

I believe it's now June 30.

Wondering if there's any rhyme or reason as to how you choose those dates?

Why isn't it May 30 or July 31?

So there is rhyme and there is reason for sure.

The answer is that we use those dates, of course between BofI and ourself to make sure we're in agreement.

But we've also used them as a way to help have a conversation with the regulator.

From a broadest perspective, I wouldn't get too concerned about them.

As you've already seen, we can with BofI's agreement move them as we need to.

But we do think those are good time lines to work towards and helps us, again, have that conversation with the regulator.

Great, thanks so much.

Your next question comes from the line of Michael Millman with Millman Research Associates.

Your line is open.

Thank you.

Can you tell us what share of the ACA business you did, or have done, to date?

Yes, Mike, I'm going to let the season play out of before we get into anything like that.

I don't think we would -- I'm not even sure how we would get that number.

We'll obviously give you a full read-out at the end of the season.

I guess what I was looking at is whether you're getting more than your average share of the total market.

Unclear at this point.

As I said, we are under the number that we anticipated for the early season, but beyond that, I wouldn't hazard a guess.

I think we'll have a better feel for that at the end of the season.

What we do know, Mike, is that the average H&R Block client is twice as likely to be impacted by the ACA than the average American, simply because of the customer profile that we serve is the people that this is really targeted towards.

So ultimately we're going to have more market share just because of that.

But within that standard, the question really is going to be answered better at the end of the season, as Bill said.

I think the one concern we have is, frankly, in the digital space.

Do you want to talk about that, Jason, specifically?

Sure.

I think it's important to point out that we actually don't have the same experience in our tax software.

As a Company, we feel it's critical to create and file an accurate tax return.

And there's a big difference in how our tax software versus TurboTax works, specifically when you're talking about the Affordable Care Act.

With H&R Block tax software, we require the filer to input his or her 1095-A in order to file.

By contrast, TurboTax does not require this, which would mean that it may be easier to actually file the return using TurboTax, but the return is not going to be accurate.

And in fact, it will actually put the return directly into IRS special processing.

Which means that the taxpayer can file, they'll get an accepted return.

But then they're going to get a mail, snail mail, from the IRS, which will require 8 to 12 weeks of additional time and an amended return, in order to then complete their return.

Maybe you've just explained a question I was going to ask.

It seems surprising that for the erroneous 1095s, that only less than 10% of them had already been filed by mid-February.

Go ahead, Mark.

This is Mark.

Mike, this is a little bit different answer.

What Jason was speaking to were people that enrolled in the marketplace and need to reconcile using a form 8962, and those folks need to use a 1095-A.

What you're speaking to is another issue that was recently announced by HHS that indicated that they had corrected 1095-As.

In other words, the federal marketplace and some other state-based marketplaces, including California, had put out notices that indicated that the 1095s they had sent out were incorrect.

Following that, HHS indicated that 90% to 95% of those folks hadn't yet filed.

So the vast majority of the folks that have to reconcile, which are virtually all the people that enrolled in the marketplace last year, still have yet to file.

I think that's the information there.

But those folks are either going to have to amend their returns if they used the incorrect 1095-A, or they're waiting to receive their corrected 1095-As.

That's, we think, contributing a little bit to the delays we're seeing.

I guess the question is you would have thought that they would be lower income, they would tend to file earlier than average.

Well, I think as Bill already mentioned in his comments, we originally thought that we would see a higher percentage of ACA-impacted clients.

But it's turning out that we are probably going to see those clients spread throughout the tax season instead.

Again, I hate to sound the way this is going to sound, we have to let this play out.

In consumer behavior, any time you have a new service, a new initiative that was instituted by the government, you've got to wait and see how it plays out.

That was our anticipation.

It has not played out that way.

We do still believe with the form errors that Mark just talked about, in general that more ACA people will be coming in over the last six weeks.

Maybe I missed something you said.

Looking at the revenues, you seem to be up about 4 times for returns that are not quite up that much.

Am I missing some arithmetic here?

Are you talking about the third-quarter results, Michael?

Third quarter.

I think you've got to be very careful looking at our third-quarter financial results and extrapolating at this point.

This was simply timing, e-file being open another 11 days.

We had a lot of returns last year that we had completed but we weren't able to file them because e-file was only open for one day in January last year.

Even then we had a limited number we could get in the door.

So you do have that discrepancy and so I really would be cautious in drawing too many conclusions from those comparisons.

Question, over the last several years we've seen, at least on IRS numbers, that assisted has either been flattish, up -- almost de minimis increases.

Where's this going in the future?

Well, Mike, here's -- this is why I'm spending an awful lot of time on this.

If the government does not make moves to combat tax fraud, some of the things that we've done that Jason outlined earlier, equalizing the standards on EITC, because that's been a significant shift, having competency exams and background checks and everything else on return preparers, I think assisted is going to struggle.

It has really come to the forefront this year how bad the fraud is in this industry.

And that's something that we as -- and that's why I'm saying, I'm glad to hear commissioner Koskinen is going to convene a group.

I think we, as industry leaders, have to come together to protect the American public.

There have to some changes.

These are huge numbers.

And consumers are suffering for this when they get a notice that their tax return has been filed and they haven't filed it yet.

Appreciate it.

Thank you very much for your --

Thanks, Mike.

There are no further questions at this time.

I will turn the call back over to the presenters.

Okay.

Thank you everyone for joining us today.

Have a great day.

We'll talk to you soon.

Bye.

This concludes today's conference call.

You may now disconnect.