H & R Block Inc (HRB) 2017 Q2 法說會逐字稿

Good afternoon.

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

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

(Operator Instructions)

I will now turn the call of to Colby Brown, Vice President of Finance and Investor Relations.

You may begin your conference.

Thank you, Mike.

Good afternoon, everyone, and thank you for joining us.

On the call today are Bill Cobb, our President and CEO, and Tony Bowen, our CFO.

Today we will discuss our FY17 second-quarter results, our thoughts around the upcoming tax season, as well as our financial outlook.

During our prepared remarks we will be presenting slides via the webcast, which will also be available on our Investor Relations website following the call.

We have also 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've reconciled the comparable GAAP and non-GAAP figures in the schedules attached to our press release.

Before we begin our prepared remarks, I will 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 FY16 and our other SEC filings.

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

At the conclusion of our prepared remarks we'll have a Q&A session.

During Q&A we ask that participants limit themselves to one question with a follow-up, after which they may choose to jump back in the queue.

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

Thank you, Colby.

Good afternoon, everyone, and thanks for joining us.

I am extremely excited for the upcoming tax season, and as we share some of our plans today I hope you will be, as well.

I am proud of my leadership team and the dedication and tenacity they have shown coming off a challenging season.

We have been hard at work developing and implementing a comprehensive and aggressive plan designed to deliver stronger results in tax season 2017.

That same spirit and dedication is echoed in the thousands of hard-working associates throughout H&R Block.

I am now entering my sixth tax season and the level of enthusiasm displayed for the upcoming season is the best I have seen.

I recently attended our Company and franchise conventions and was motivated by the energy level of the attendees.

We are all ready to deliver.

Before diving into why we're energized for the upcoming season, I'd like to outline what we intend to cover during today's call.

First, we will have a short discussion about our second-quarter results.

Then, I'll provide some thoughts around how we will define success in both the short and long term.

Next, I will share some key elements of our plans for the upcoming tax season.

Tony will then review our second-quarter financial results and our financial outlook for FY17.

And, finally, I will close out with thoughts on why we believe H&R Block is such a compelling investment.

With that, let's talk about our second-quarter results.

Overall, we are on track with our financial plans, and Q2 results were in line with our expectations.

We are pleased to report an increase in revenue and an improvement in both operating expenses and our pretax loss.

Now that we have hit the halfway point of the fiscal year, we are starting to realize some of the benefits of our previously announced cost-reduction efforts, which will not be fully realized until year end.

And with our plans for this tax season now set, we have identified the areas in which we will invest to be successful.

Tony will talk more about this later.

I'm also pleased to discuss some good news in the fight against tax fraud.

The public-private collaboration through the IRS Security Summit made a positive impact last year, as demonstrated by a decrease of over 50% in the number of new people reporting stolen identities on federal tax returns.

We will continue to make progress this season through stronger authentication measures in the DIY category and better information sharing among tax software providers.

In addition, the Protecting Americans from Tax Hikes, or PATH Act, will take effect this season.

The IRS will now have additional time to review tax returns containing the earned income tax credit and the additional child tax credit before processing refunds.

While this will delay refunds for as many as 15 million tax filers until late February, it will help cut down on inaccurate or fraudulent returns, which is something we fully support.

So, there has been a great amount of progress in the fight against tax fraud, but the work is far from complete.

As an example, taxpayer safeguards such as minimum standards for return preparers have not yet been implemented.

We will continue to advocate for the honest taxpayer in this fight.

While we're talking about the industry, let me address something many of you have been asking about the past few weeks, the recent election results.

First, we congratulate President-elect Trump on his election victory.

We look forward to working with Congress and the President-elect's team in the coming months.

Some within the investment community have expressed concern about the possible negative implications for H&R Block that might result from the new administration's policies.

I'd like to take a moment to provide an alternative viewpoint to these concerns.

Like you, we have been listening closely to the comments of the President-elect and his nominees for key cabinet positions.

Treasury-nominee Steven Mnuchin has talked about the desire to lower corporate tax rates and to have a middle class tax cut that includes increased child tax credits and other rebates.

There's also been discussion of limiting mortgages and charitable deductions and raising standard deductions.

So, as you can tell, there are a lot of moving parts.

On the Affordable Care Act, Health and Human Services Congressman Tom Price has talked about repealing the ACA and replacing it with a new program that could include refundable credits.

The President-elect is on record for wanting to retain certain aspects of the ACA, such as coverage for dependent children up to age 26, and covering people with pre-existing conditions.

It's also our understanding that any proposed changes will not impact this tax season, and as media are reporting, they may not be effective for two or three more years.

While there are many questions about changes to the ACA, we don't expect there to be a material impact to H&R Block, regardless of the outcome.

Finally, potential changes to the corporate tax rate, specifically reducing the rate to as low as 15%, could be a significant benefit for H&R Block.

Given our historical effective tax rates in the mid 30% range, such reductions would have a material positive impact on our net income and cash flow.

So, as you can tell, the dialogue on tax policy is far from vague.

Most of what we've heard is from the incoming administration, but Congress will have a great deal to say, too.

Regardless of the outcome, people will still need help to sort through the changes and the impact on their taxes.

Thus, I am absolutely certain of one thing: taxpayers will continue to need and want H&R Block's help.

The tax code was much simpler when this Company began in 1955.

People wanted our help then, just as they will in the future.

We remain laser-focused on helping our clients this coming season, the season after that, and for many years to come.

Shifting gears, let me talk about our plans for the future, specifically focusing on defining what success means to H&R Block.

Ultimately, return volume is key to how we will measure success.

We understand this and are focused on addressing recent client losses.

But this is not something that can be solved in one season.

To that end, we would like to share with you how we are defining success in both the short and long term.

In the short term, we are focused on arresting the client decline.

In our assisted business, given the losses we've experienced over the last several years, it is unrealistic to think that in one year we will be able to move from losing clients to client growth.

We believe, however, that we will be able to significantly reduce the client loss this year as we move toward client growth in the future.

And for our DIY business, we do consider last year's performance to be an anomaly as we were able to successfully grow clients for five consecutive years prior to last tax season.

In the long term, our goal is to grow clients in both the assisted and the DIY categories.

To accomplish this, we are approaching assisted tax preparation in a different way, by focusing on enhancing our client service delivery model, which really hasn't changed much in decades.

In DIY, we've made significant progress in our user experience over the last several years, as validated by the strong independent reviews we received last tax season.

We're building on this progress by adding more client-friendly features, designed to improve the DIY tax preparation experience.

While the objectives I just outlined center on arresting the client decline this tax season and growing clients in the long term, they must be accomplished while maintaining our financial health.

We are a financially sound company with enviable margins, strong free cash flow, and a solid balance sheet.

And we intend to stay that way.

Let's talk more specifically about the changes we're making to achieve this success.

We've been hard at work this pre-season developing a winning approach to tax season 2017, which includes changes in all customer-facing areas of the business, including our sales and service model, promotions, pricing and products and market.

I'll now talk specifically about each of these areas, providing details on what we plan to do and how we believe these plans will translate into results.

Let's start first with sales and service.

After last season, it was clear that changes at the office level were necessary.

This included a new approach at the local level regarding how we attract our clients, and improvements at the tax desk, or how we serve our clients.

Ultimately, it was time for cultural changes in both areas.

From a sales perspective, we have spent the pre-season emphasizing with our field management and associates that not only is delivering excellent service important, but that they are also the best sales agents for our brand.

We have provided training opportunities to enhance their sales skills, developed new sales programs including a B2B sales plan in which we are partnering with local and national businesses, and hired experienced sale managers to further the sales culture.

Our field leadership has been energized by this new approach and I am extremely pleased with the level of engagement we've seen to date.

So, while that addresses how we can drive client volume at the local level, we also recognize that we need to enhance the client experience once they are in our offices.

Our service delivery model hasn't changed significantly in decades and we felt it was time to deliver a fresh, new approach to tax preparation.

We know from our market research that consumers want a more dynamic, personalized and engaging experience, which we intend to deliver.

We expect most of those changes to the client experience to occur in the second half of the season, so you'll hear more about it later this fiscal year.

In addition to instilling a sales and service mentality, we've also addressed gaps in our product and pricing strategies this off-season with a particular focus on early season assisted clients and DIY tax filers.

I'll address our three most significant efforts in these areas -- the refund advance, our free federal 1040EZ promotion, and free DIY.

Starting with the refund advance, early season clients typically have a compelling need for cash and want to access their tax refund faster than the customary two to three weeks.

The impact of the PATH Act may further increase this need as refunds for over 15 million early season filers will be delayed until late February.

In tax season 2017, H&R Block's refund advance will directly meet that need.

The refund advance is a no interest, no fee loan that provides our clients quicker access to their cash.

We worked hard with our bank partners to develop a program that will be seamless for the client, built into the tax interview, and will provide the best product and service experience available.

Tony will cover the details of this offer later during his remarks.

The next offer in our lineup is the reintroduction of our free federal 1040EZ promotion in our retail offices.

The market is not the same as it was when we last offered this promotion.

Specifically, the competitive landscape and the fight to attract simple tax returns has changed dramatically over the past couple of years with the introduction of numerous DIY free product offerings.

For simple returns, free is now the norm, rather than the exception.

That said, we believe that there are tax filers using a free DIY product who would prefer assistance, but are swayed by the free offers in the digital space.

The free federal 1040EZ offer will address those taxpayers' needs, providing tremendous values and driving filers to our offices during the early part of the tax season.

Finally, given the changes in the DIY category, we recognize that to compete we had to re-evaluate our pricing structure.

Last year our product lineup and pricing did not align well with the competition.

As such, we have made changes to our product line and are now offering a free federal, free state product for 1040EZ and 1040A returns.

But it's not just about the offer.

We're also stepping up our game in terms of the product.

We are excited about the new features and capabilities we will offer, such as the ability to easily import last year's tax return from any other tax preparation service or provider, or the capability to take a picture of your W2 to easily import your information and get started quickly.

With the user experience that can stand up to any in the DIY category, and the right products at the right price, we believe we can achieve DIY client growth this season.

Now that we've discussed our approach to sales and service and our pricing and product changes for the season, I'll mention a few things about our marketing efforts.

We know that last year our message missed the mark and did not yield desired results.

Thus, we spent the pre-season working to ensure that we better understood the value that clients are seeking and aligning our value proposition accordingly.

What you will see is a more cohesive marketing approach for H&R Block, with a new look, a new tone and a new value proposition that will appeal to tax filers.

Additionally, we will more efficiently allocate our resources.

We've eliminated programs that were not yielding results.

In tax season 2017 we will have lower marketing expense overall, but it will be spent more effectively.

We will communicate our new assisted products and promotions timely and loudly.

And our messaging will be stronger in our DIY business, with the goal of driving awareness and highlighting our value proposition in that category.

So I've covered a lot of ground, describing our vision of success and the changes we are making to achieve our objectives.

I'll now turn the call over to Tony to talk about the details of the second-quarter results and to provide a financial view of the upcoming season.

Thanks, Bill.

Let me start by taking a few minutes to review the results of the second quarter.

As a reminder, due to seasonality of our business, the results in the second quarter are not indicative of our performance for the full year.

Additionally, this will be the last time in which year-over-year comparisons for the quarter are impacted by the divestiture of H&R Block Bank and the capital structure changes which occurred last year.

In the quarter, revenues increased approximately 2% to $131 million, primarily driven by foreign exchange and our international operations, as well as improved product revenue in the US.

Total operating expenses decreased from the prior year by $23 million or 6%, due primarily to one-time costs of $21 million incurred in the prior year related to the divestiture of H&R Block Bank and our capital structure changes.

Even excluding this impact, operating expenses declined due to our cost-reduction efforts, which were mainly realized through lower compensation and benefits.

Partially offsetting these reductions were occupancy and amortization expenses related to franchise and independent acquisitions in the prior year.

The favorability in revenues in operating expenses were partially offset by increased interest expense as a result of the long-term debt issued in the second quarter of FY16 and prior-year gain on sale of securities.

Netting all of the changes, pretax loss improved 4% or $9 million.

Our income tax benefit was lower in the quarter, primarily due to a lower base tax rate.

As a reminder, a reduction in our tax rate will be beneficial for the full fiscal year, but reduces the benefit in quarters in which we record a loss.

I'll provide additional thoughts on our income tax rate when discussing our outlook for the fiscal year.

Finally, loss per share increased $0.13 to $0.67, which was entirely due to the reduction in share count as a result of our share repurchases over the last 12 months.

As a reminder, in quarters with a loss, reducing the share count negatively impacts the loss per share.

Turning to our balance sheet, there are a couple of areas I'd hike to highlight.

You may recall that H&R Block Bank owned a mortgage portfolio to satisfy regulatory requirements.

When we divested the bank we decided to retain the mortgage portfolio, as market conditions were not favorable at the time.

Given improving market conditions, we have now decided to sell this non-core asset and have moved mortgage loans held for investment to held for sale.

We expect to complete the sale in the fiscal third quarter and receive cash proceeds of approximately $190 million, which is above current book value of $183 million.

This allows us to streamline the balance sheet and accelerate cash flow, which we will fold into our overall capital allocation approach.

In the second quarter we also continued to take advantage of the current share price, repurchasing 7.6 million shares at a total cost of $168 million.

In total, we have repurchased 9.6 million shares for $217 million in FY17.

We remain committed to opportunistically repurchasing shares as a component of our overall capital allocation strategy.

As we look forward to tax season 2017, we are very excited about our new offerings.

Following the announcement in late October regarding our refund advance product, many of you have inquired about how the product will work for the consumer and what the financial implications are for H&R Block.

So, I'd like to spend a few minutes discussing the details.

The refund advance is an interest-free, no fee loan available to our assisted tax preparation clients.

We have partnered with our existing Bank partner BofI and MetaBank to offer this consumer-friendly product.

From an operational perspective, we feel it is important to make the application and approval process as easy as possible for our clients.

To obtain the loan, the client completes the application at the tax desk during the preparation of their tax return.

The tax professional then submits the loan application electronically to MetaBank for loan decision.

Loans will be made in amounts of $500, $750 or $1,250, and most approved clients will have funds loaded onto Emerald Cards within 24 hours.

This will be a seamless process for our clients.

H&R Block will pay a fee of $32 to $36 on average for each loan, which is intended to cover loan origination fees, servicing costs and expected losses, among other items.

The fees will be recorded as a cost to revenue and will not be passed along to our clients, either upfront or on the back end.

Franchisees will pay H&R Block a royalty for each loan at an amount slightly lower than the fee H&R Block is paying BofI and MetaBank.

And while refund advance will not directly increase revenues, it will provide a tangible benefit to our clients and positively contribute to Emerald Card revenue and volume.

Ultimately, the financial results of the program will be dependent on the number and mix of clients electing to take a refund advance.

One final note -- to ensure we have the appropriate level of funding in place, we have secured an additional $200 million of capacity from our refund advance partners under the same economic terms as the original agreement.

#This brings our total available funds under this program to $1.65 billion.

We're excited to offer this valuable product that will appeal to many early-season assisted tax filers.

Turning to our financial outlook, let's start by discussing return volume and pricing.

As Bill mentioned, we don't expect to grow assisted return volume this tax season, but we have the right strategy in place to deliver client growth over the long term.

We do, however, expect to significantly reduce the client loss this tax season.

With regard to assisted pricing, let me walk through some of the specifics.

Given the changes in the competitive landscape we discussed earlier, free has become the new norm for the simple tax return.

As Bill mentioned, we will be offering the free federal 1040EZ promotion in the early part of the tax season.

Other forms in our assisted business will see moderate price increases, recognizing we cannot expect to arrest client decline and ultimately grow clients while aggressively increasing price.

We expect these changes to result in a flat to slightly down net average charge in our assisted business when compared to the prior year.

Turning to our DIY business, we believe that last year was an anomaly.

And with the enhancements to the user experience, changes in pricing and increased awareness we can grow clients this tax season and beyond.

In terms of DIY pricing, our approach the past couple years has varied from the market leader.

For example, our free product did not include EITC or a free state return.

In tax season 2017, we will be more aggressive in our approach which will require modifications to our product lineup.

By making changes such as including EITC in our free product, we will better align with other providers in the marketplace and appeal to more DIY tax filers.

The changes to our product lineup, coupled with our free federal, free state promotion that Bill discussed, will result in a lower overall net average charge this season for our DIY business.

This essentially represents a bit of a reset year for us with regard to pricing, especially in our DIY business.

Going forward, we will continue to evaluate the optimal pricing model to achieve client growth while not sacrificing the overall financial health of the business.

These pricing changes, coupled with our promotional efforts including the refund advance, will make us more competitive in both the short and long term.

Turning to EBITDA, to offset the incremental expense of these initiatives we announced cost reduction efforts in June.

I am pleased that, as a result, we will continue to maintain a healthy EBITDA margin.

When considering these changes as well as the ongoing impact of the Bank transaction, we are setting our expected long-term EBITDA margin at 27% to 30%.

We anticipate FY17 to come in at the lower end of this range, which is comparable to last year's adjusted EBITDA margin of 27.6%.

I'll now move through other areas of our financial statements.

Starting with CapEx, we are capital light with minimal investment needed to run our business successfully.

After peaking in FY14 due to needed office improvements, CapEx levels have moderated to levels we would expect for the foreseeable future.

In FY17, we expect CapEx of approximately $90 million to $95 million.

Long term, we expect CapEx to run at approximately 3% to 4% of revenues.

In regards to acquisitions, over the past two years we have purchased approximately 600 locations that were previously franchised.

These acquisitions are typically completed at levels below our trading multiples, and, as such, are accretive to earnings.

As we've discussed in previous calls, however, the opportunity for franchise acquisitions will moderate while we expect to continue with similar levels of independent acquisitions.

We anticipate closing out the year having repurchased approximately 145 franchise locations and acquiring 65 independent locations for an aggregate purchase price of approximately $60 million.

Moving to depreciation and amortization, given the level of franchise repurchases and capital expenditures, we anticipate FY17 to be the peak year at approximately $175 million to $180 million.

In general, approximately two-thirds of our D&A is CapEx-related, while the remaining one-third is related to acquisitions.

In regards to capital structure, you'll recall that last year we made significant changes, issuing long-term dent and putting into place our $2 billion line of credit.

I'm pleased that we were able to extend the maturity date of the line of credit an additional year to September 2021.

And regarding our overall level of debt, we continue to target adjusted gross debt to adjusted EBITDA levels of 2.5 to 3 times, and are currently within that range.

We believe this will help us achieve our stated objective of maintaining investment grade credit rating metrics.

Following these capital structure changes last fiscal year, interest expense is expected to be approximately $90 million to $95 million.

In regards to share repurchases, the year-to-date weighted average fully diluted shares outstanding at the end of the second quarter was approximately 218 million shares.

This number will decline on a full-year basis due to the weighted average share calculation as our shares outstanding at the end of the quarter were approximately 212 million.

As I mentioned earlier, going forward we will continue to purchase shares opportunistically and have approximately $1.3 billion of our $3.5 billion share repurchase authorization remaining.

Finally, we continue to do a lot of work around our corporate taxes, and going forward we expect our long-term effective tax rate to be approximately 34% to 36%, with FY17 coming in at the low end of this range.

Note that this range does not consider any implications of future corporate tax reform, which, as Bill mentioned, would likely be positive for the Company.

I'm excited about what we have in store for this upcoming tax season and beyond and I look forward to sharing the results with you after the third quarter.

With that, I'll now turn the call back over to Bill for some closing comments.

Thanks, Tony.

I thought it was important to share all that detail regarding our plans and outlook, so thanks again, Tony.

Before I conclude, I want to address a personnel change that we just announced in an 8-K filed this afternoon.

Greg Macfarlane, our Senior Vice President of US Retail Operations and Products, has decided to leave the Company at the end of this month.

Earlier this year he transitioned to an operating role and performed at his usual high level, as evidenced by his many contributions to our tax season readiness.

He will be missed, but we have a strong bench of leaders who are ready to seamlessly take over Greg's responsibilities and execute our plans in season.

Personally, I want to thank Greg for his leadership over the past four and-a-half years in both his current role and previously as our CFO.

I am grateful for his many contributions and his friendship.

We wish Greg all the best as he pursues the next phase of his career.

Now I'd like to wrap up by spending a few minutes discussing why we believe H&R Block is a strong long-term investment.

H&R Block offers investors an opportunity for growth, value, and stability.

We participate in an industry that offers predictable and consistent growth.

Tax filings in the US have historically grown at 1% to 2% and we expect that to continue.

Our tax-plus products contributed over $400 million of revenue in FY16 and are a differentiator in the marketplace.

While the addition of the refund advance product does not generate standalone revenue, it is expected to positively impact client volumes and increase the usage of other key products, such as our Emerald prepaid MasterCard.

Opportunity for growth in the DIY tax preparation category continues.

We are the number two player in the category and are well positioned for future growth.

And as a reminder H&R Block is the only tax preparation company that offers taxpayers the ability to complete their taxes in whatever way they choose.

Whether that be through assistance, using a DIY method, or options that incorporate aspects of both methods, H&R Block provides solutions for all tax filers.

And, finally, there continues to be growth in the international space.

Our operations in Canada and Australia provide tangible value to H&R Block, and the opportunities we are cultivating in India will benefit us in the long term.

From a value perspective, we are taking measures to ensure that our growth will not come at the expense of the bottom line.

By taking the previously discussed cost reductions to fund client growth initiatives, we are able to maintain enviable EBITDA margins.

We run a capital-light business which requires minimal infrastructure investment to operate successfully.

In fact, our return on invested capital is consistently in the top quartile of the S&P 500.

And ultimately the excess cash we generate is returned to our shareholders through both share repurchases and dividends.

This fiscal year we announced a 10% dividend increase.

We've paid quarterly dividends consecutively since going public over 50 years ago and deliver a strong dividend yield, well above the average in the S&P 500.

Finally, regarding share repurchases, since the start of my tenure we have repurchased approximately 102 million shares for $2.7 billion.

Including dividends, total cash returned to shareholders over this time amounts to $3.9 billion, which is more than double our net income over the same period.

In closing, I want to thank our shareholders.

Last year was challenging and we appreciate the support you've shown.

Although we believe we have a plan that will deliver stronger results in tax season 2017, we understand that plans are just that and it is what we deliver that matters.

We are playing to win and we look forward to sharing mid-season results with you after the third quarter.

With that, we'll now open the line for questions.

Mike?

(Operator Instructions)

The first question is from Gil Luria from Wedbush Securities.

Good afternoon.

I see you're giving us EBITDA margin guidance.

In terms of revenue guidance, though, if you're talking about not quite stemming the loss of volumes and having prices flat to down, is there going to be enough offset in digital, international and financial products to create any type of growth in revenue?

Or should we expect overall revenue to decline in this fiscal year?

Thanks, Gil.

We're not going to provide specific guidance for the overall revenue number, obviously.

I think ultimately it will depend on the mix of clients, what the final growth is in both our you assisted and DIY business.

To your point, we do have some upside potential from product revenue.

Obviously the franchise buybacks that we've been doing will also provide a benefit.

But we're not going to put a specific revenue target for the upcoming season.

Then as a follow-up, in terms of the cost of the refund advance, $32 to $36 a loan, it sounds like, order of magnitude, if you lend out the entire 165, that's about $50 million of cost.

Did you say that's going to be contra revenue?

Where are we going to see that $50 million come out?

It will be in cost of revenue.

Cost of revenue.

Expense.

Yes.

Okay.

Thank you very much.

The next question comes from Kartik Mehta from Northcoast Research.

Hey, Bill, hey, Tony.

Tony, I wanted to ask you a little about the EBITDA margin guidance, just to understand better.

Did you say it was going to be flat compared to last year or did you say lower end of your 27% to 30% guidance, more closer to 27%?

The range, Kartik, is 27% to 30%.

We think it's going to be at the lower end of the range for this upcoming season, which, the statement I made, was comparable to last year, which we ended at 27.6% on an adjusted basis.

We didn't provide the exact number, but it's in the 27% range.

Okay.

And then I know in the past you've not talked about cost cutting, but I look at what you're doing to drive clients, the free RAL, the free 1040EZ, the free DIY, and you're anticipating probably flat to slightly decline in pricing.

So, I'm wondering, can you provide a little bit more detail about the cost cuts you're making that will allow you to stay in that 27% EBITDA margin range?

Yes.

And, Tony, if you want to add anything at the end here.

Kartik, we have not specified exactly where the cuts are, but you can see from our numbers in the release, et cetera, our compensation and benefits expense is down.

As I said in my remarks, marketing expense will be down.

There are also field expenses that will be down.

So overall, when we did the cost reduction efforts last March and April that we announced in June, they were comprehensive.

They were across the board.

And they were in anticipation of knowing that we were going to have to get very aggressive with some of our offers.

So, those are some of the specific areas that we are reducing, but at this point we're not ready to talk about the exact number.

I will add -- and then, Tony, if you want to add anything -- as you know, given that 76% of our business, our revenue is done in the fourth quarter, the large majority of the expense reductions will occur at that time, which is when we do our business.

Yes, I think to Bill's point, we aren't providing the specifics on the cost reductions.

It's obviously netted in our EBITDA margin outlook.

It's really allowed us to be aggressive this year with adding the refund advance, bringing back 1040EZ, being aggressive in DIY.

But we aren't breaking out each individual line of the cost items.

And just one last question, Bill, free 1040EZ, you've tried it in the past, then you decided not to do it again for a while.

You're bringing it back.

I just wanted to walk through what's different this time.

Why bring it back?

What did you learn and how will you do it differently?

It's a little hard to do it differently.

It's free.

I think what changed, Kartik, was the industry.

Obviously Turbo got very aggressive with simple returns.

We had many more offerings in the DIY space and in the assisted space.

Again, simple returns.

So, I think to look back and try to project forward, it was a different time and a different place.

There wasn't a proliferation of free offerings.

Now there is.

So, for us to compete.

And I think part of what we're trying to indicate in how we're going forward is we are trying to compete across all filers, across all taxpayers throughout the entire season.

So, that is the difference.

It was successful for us in terms of driving the number of clients and we think it will be successful again.

Again, we do have in the offices other ways to monetize that client.

We actually have more ways than we had back then, such as the addition of the tax identity shield.

That is part of the reason we brought it back, but effectively it was competitive conditions.

Thank you very much.

The next question is from Scott Schneeberger from Oppenheimer.

First question for you guys, a few moving parts, a lot of moving parts, it does look like it will be a challenge on the low end of the EBITDA margin guidance.

I'm curious just if you would be so kind as to rank order your priority of delivery, a 27% handle on EBITDA margin, arresting client growth or relative pricing, although that's probably fixed going into the season.

How do you rank order those, Bill, as far as what you'd like to deliver, to the extent you control?

Thanks.

Yes, Scott -- and, Tony, if you have a different approach -- I don't view it as a rank order.

We had crafted this plan, a lot of modeling, a lot of iterations.

But this is designed to come together to yield a margin, as we said a couple of minutes ago, in line with where we wound up last year, but with a significant change in the client loss on the assisted side and client growth on DIY.

Now, any change of this magnitude, as aggressive as we're going, volume and mix will be indicators of this and we will adjust as we see forward.

But we want to deliver across the board on what we've talked about here.

So I'm not sure -- and, Tony, I don't know if you have anything to add -- I would characterize it as rank order as opposed to this is a thorough and complete piece of plan.

The only thing I would add, Bill, is I think it's a balance.

I think it's a balance across the financial health, as well as change in trajectory of the clients.

And we talked about that from the beginning.

I think this plan does exactly that.

We haven't really thought about them as tradeoffs but more of a balance of price, investment and promotions, cost reductions and ultimately maintaining a good EBITDA margin.

So, it's really a balance across all aspects.

Scott, again, this is a qualitative factor.

I made some comments in there.

We are playing to win.

When I was at the convention this year, we have a charged up franchise and Company teams.

The sales and service move has been a big move for us with our Company operations.

I like the fact that as we go forward with this plan that we just talked about, it's being done in a way that we're going to swing the bat this year.

Okay.

Great.

I'm curious on the refund advance loans, it's going to be tricky to maintain.

Obviously the client is not responsible for the bank fees.

The tax preparer is.

You have new and existing clients that are going to take these.

This is essentially a tool for a client acquisition.

How are you managing that in delivery?

Are you able to manage that in delivery?

Thanks.

Ultimately the application and approval process will be ran by MetaBank.

We've got estimates from them on what we think that's going to be.

And, to your point, this is a client acquisition vehicle for us.

We're trying to drive new clients into the door.

We do think that we're going to get some uplift in retention for prior clients, as well, but the ultimate success of the program will be how many incremental clients we bring in during the offer period.

When you have a client decline like we had last year, Tony's absolutely right, new clients are going to be the key.

We want to make sure prior clients came in, too.

So we did not limit this.

We want this to be a thorough offering.

We want to create traffic in our offices, excitement in our offices.

Tony and team did a terrific job working with our partners on upsizing the capacity.

So, we're ready to go forward on January 9.

Thanks.

And one more follow-up along the refund advance theme.

You mentioned franchise buy-in.

Do you have 100% franchise buy-in or participation in the refund advance?

And I believe I heard, they will be contributing in something less than that $32 to $36 per.

Tony, could you just confirm that, maybe elaborate, too, a little bit more?

And then part of this question is also, it sounds like you had lower marketing expense last year.

You had the sweepstakes that I believe cost about $35 million.

So, all of these initiatives we speak of are going to be less than that in the whole kit and caboodle.

Whatever you can share there, Tony.

Thanks.

Let me try to make sure I captured all that.

First of all, we're not going to disclose the specifics around the franchisees.

Let me say that the take-up of participation on this is extraordinarily high.

I'm not sure it set a record but it is extraordinarily high in terms of franchise participation.

And obviously it's 100% on the Company side.

In term of the cost to the franchisees, we're not going to give the exact number.

I think Tony said it in his script, we gave you what the cost of each loan will be.

The franchisees will pay a fee per loan.

They will not participate in other costs.

And they have been receptive to that so that they can really have cost clarity around that.

But I'm not going to give you the exact number.

With regard to marketing expense, last year our marketing expense in the K was $298 million.

What we are saying is, based on the reallocation we have done, the elimination of certain programs, et cetera, we will have a lower number on that line when we're finished with the tax season.

However, I do think, as I said, we are taking a different approach to marketing.

It's going to have a new look, a new tone, a new value proposition.

Impact matters and I think we will have impact.

I don't think people will miss our offers as we go forward.

The only thing I would -- and I'm not sure exactly where you're going with your question, Scott -- but the refund advance costs that we're paying are not part of marketing when we're setting that up.

So, I wasn't sure if you were trying to back the refund advancement.

It's really outside of marketing.

But marketing, excluding refund advance, will be down this year.

It's all in OpEx though, right, Tony?

Correct.

Okay.

Thanks.

I'll pass it on.

Thanks, guys.

The next question is from Thomas Holland from Morgan Stanley.

Good evening.

The biggest surprise for me for the quarter was the buybacks.

Can you just talk a little bit more about it?

A, what is your leverage today?

B, you are going to realize the gains from those mortgages next quarter.

Did you prefund that, or did you do buybacks ahead of that?

And, C, are you going to be buying back during tax season this year?

Thanks.

I think it's just generally about buybacks and how we're thinking about it.

We've now done about a little less than $220 million for the first two quarters.

As we talked about, we're going to opportunistically buy when the price makes sense.

I think you said you were a little bit surprised.

I think it's in line with our expected capital plan over the next several years.

Obviously we're not going to talk about what we're going to do for the remainder of the year but we'll opportunistically purchase, as we've said.

I think that covers most of it.

I think Thomas also asked will we be buying in tax season.

Last year we did.

Again, I'm not going to commit to whether we are or we aren't but we showed last year that we have the capability to do that.

Whether we will, our stated approach has been not to disclose ahead of time whether we decide to take advantage of a price at a particular point in time.

But last year we did prove that we're able to do that.

And just high level, can you just remind us of what your policy is on buybacks now?

I think you guys did back away from the bigger target that you set a few years ago, or last year?

So, what's it now, the strategy?

It's a pretty big target.

We still have a $3.5 billion authorization remaining.

That's through June 2019.

That hasn't changed.

There's been no backing off on that, Thomas.

Okay.

Perfect.

And then just on the franchise and independent acquisitions, any expectation on how many returns that should add to the system in 2017?

And then how many did it add in 2016?

Thanks.

I think you asked about the franchise, buybacks and acquisitions?

Yes, exactly -- franchise and independents.

The franchise buybacks obviously don't add any incremental.

We're just moving from franchise operations to Company, so it's a little bit of left pocket to right pocket.

I think we're going to do about 145 offices this year.

On the competitor acquisitions, those locations typically do 1,000 returns an office.

So, we would expect somewhere in the range of 60,000 to 80,000.

And that's fairly consistent over the last few years, Thomas.

Perfect.

And then final question from me, with Greg leaving -- and, Greg, you'll be missed -- who's going to be taking up his responsibilities?

Thanks.

What I've done is I have moved different -- I'm not replacing Greg, per se -- I'm moving different parts of his team to different leaders.

We're not going to talk about specifically that, but essentially it reports in, my direct reports have absorbed some of that.

So, we divvied it up.

Greg had a very specific role that was really played to his strengths.

So, what I've done is I've taken operations areas and moved it to more operations people, and product to marketing and things like that.

Helpful.

Thank you.

The next question is from Jeff Silber from BMO Capital Markets.

Thanks so much.

I want to go back to the refund anticipation loan.

I'm going to ask a stupid question.

Is that only available for customers that file returns through you?

And is it also available for both assisted and DIY?

It's not a stupid question, neither one.

Yes, you have to file because the underwriting occurs after the return has been filed.

We are going to open up the ability to have a refund advance before e-file opens.

But you still have to file the return.

And it is only available in retail offices or assisted offices.

I don't know if there's any more detail you want to give on the --.

I think you covered it.

And when you've had products like this in the past, I'm just curious if you've studied the stickiness of these customers, these new customers when you get in.

What are the retentions on this group going forward?

Obviously this specific product is new to us.

We've had refund anticipation loans in the old days but those were a very different product and, frankly, that was six-plus years ago.

We would expect retention to be in line with other new customers.

People are brought in by the offer.

We wouldn't expect retention to be materially different than other programs that we've ran in the past.

I think, Jeff, the other piece that we will be learning this season is with the PATH Act, this puts a spin on this where people are delayed.

While there's been a lot of talk of refunds being delayed until February 15, the reality is that the funding to a particular taxpayer's account or card or whatever really won't occur until more like late February.

This is a number of weeks that people will be waiting for cash at a time of the year when people are really looking for cash.

We think that's an advantage for this product.

The other piece is, this product is -- there's no interest.

So, no matter how long the refund is out, they have that access to that cash and they're not going to be charged any interest there.

So, from a consumer perspective, from a taxpayer perspective, it is about as client-friendly a loan as you're ever going to find.

Okay.

If I could just sneak in one more.

I know you're not giving specifics on the cost cut, but I'm just wondering if you've reviewed your office footprint.

Is that part of the cost cuts that we're going to see this year or is that something we may see going forward?

Thanks.

Jeff, we've done normal trimming around the office footprint, but we think overall our number of locations will be fairly consistent year over year.

We obviously look at the profitability of all of our offices every year, and always open a few in new and expanding areas and we always close a few that are underperforming.

But it's fairly modest in the grand scheme of things.

On balance, that was not a big part of the cost reductions.

Okay.

Appreciate the color.

Thanks so much.

The next question is from George Tong from Piper Jaffray.

Hi.

Thanks for taking my questions.

Can you discuss your overall pricing strategy in the assisted category for 1040As and 1040 forms, whether the intention is to decelerate pricing growth or whether the plan is to reduce prices?

I'd say for this tax season we talked about we're obviously going to have the 1040EZ offer.

The rest of the forms will see modest price increases.

We are going to slow our price increases going forward.

We just think it's important.

Given the client loss we've had the last few years, we're going to be much more slow to increase those prices in the coming years.

Got it.

And back to EBITDA margins, since most of the cost reductions will come in probably late fiscal 4Q, and some of the early season promotions will start in fiscal 3Q, how do you plan to balance the puts ands takes between the cost to fund the promotions and the savings associated with restructuring?

Let me say one thing about this and then I'll let Tony answer the specific about funding.

We still do not know what the e-file date is.

With our particular business, trying to manage to quarters is not an effective -- it really does come down to the full season.

We can't recognize revenue until e-file opens.

We don't know that.

If part of your question is around quarterly performance, that's always hard to judge in our particular industry.

Now, as far as funding, Tony, do you want to take that?

I was going to say essentially the same thing.

We're really focused on, George, for the full fiscal year.

I'm not concerned about quarter-to-quarter results as much.

And whether what occurs in the third quarter, to your point, we're going to be going out aggressive with promotions, some of the cost savings are going to hit in Q4.

We're really focused on how it impacts the full fiscal year.

But the CLOC will be the main funding mechanism.

We have plenty of liquidity to fund any e-file open date.

Right.

The question was around, is there risk that the aggressive promotions will cost more than the costs that you eventually see down the line, the cost savings.

I think the biggest risk to our plan always is the client volume that's coming into our system and DIY businesses, and that's no different this year.

Got it.

Thank you.

The next question is from Hamzah Mazari with Macquarie.

Hi, this is Kayvan Rahbar filling in for Hamzah.

A question for you guys surrounding leverage.

How much more do you guys think you might have to be able to take on and still be investment grade?

And will any of the potential future tax change implications have an effect on the appetite for leverage or decreasing it?

What's your thoughts on all that?

As far as leverage, we think we're at an appropriate level now.

We shared this back in June.

We have no plans to issue debt in the short term.

Obviously as EBITDA and profitability change in the long term we'll continue to evaluate.

But we think the range that we're in now, which is 2.5 to 3 times is appropriate.

We have no plans to do anything different.

And I couldn't quite hear you on the second part of your question.

If any of the speculation of the tax changes that might be out two, three years from now, would that impact any of that, any of the leverage?

I think it would if they took effect.

But again, that's more waiting until it actually happens.

Tony has been clear that we are not seeking at this point in time any changes in our debt level, with regard to whatever policy changes emanate from Washington or state governments, whatever.

We'll have to wait and see how that plays out.

Okay.

Thank you.

The next question is from Anj Singh from Credit Suisse.

Hi, guys.

Thanks for taking my questions.

Apologize for some background noise.

I just wanted to follow up on that pricing question.

How should we be thinking about pricing, net pricing over the longer term?

And related to that, should we expect the free 1040EZ promotion on assisted side to be a perennial offering?

Anj, I think two parts to your question.

One, how are we thinking of pricing over the long term.

I assume you mean in the DIY business.

And the second part was are we assuming that 1040EZ is essentially -- free EZ is here to stay, I think is your two questions.

Is that right?

More net pricing on the assisted side.

I think this year you guys are talking about flat, slightly down.

But how should we be thinking about that net pricing over the longer term?

I would say this year is a little bit of a reset because by relaunching the free EZ, it's the reason that we're flat to slightly down.

The rest of our forms are taking a modest price increase.

So, I think going forward we would expect essentially a modest level, which would probably be in the positive territory because the main reason that it's flat to down this year is simply because of the 1040EZ free promotion.

But much more modest going forward.

Understood.

And as it relates to the ACA and the percent of your filers that are impacted by the ACA, do you guys have any preliminary expectations for tax season 2017?

I think our expectation, Anj, at this point is it will be consistent with last year.

I think that's our best estimate at this point.

Understood.

And one final one from me.

On DIY, do you guys have any thoughts on the new competitor that seems to be popping up and offering a free promotion?

We've seen news about Credit Karma perhaps getting into the game also on the DIY side.

Any thoughts on how that might change the dynamics for you and the broader DIY category would be helpful.

Thanks.

There was a press release put out today.

I obviously haven't spent a lot of time on it.

This is a very different approach because, as I read the account of it -- and, like I said, I haven't spent a lot of time on it -- to come out with a tax product, which is essentially, the business model is, we're going to sell your taxpayer information to advertisers, I'm not sure is going to be great.

We know this industry pretty well and people are very protective of their information, their taxpayer information.

I haven't looked at it very closely, but that one stuck out because obviously one of our principles is we protect our client's privacy, we protect their data.

We do not sell data.

And it looks like this is fundamentally about selling data, which I don't think is smart in tax preparation, but we'll see.

The other thing I would add is we do have a free product, as well.

We just said today that we're offering free federal and free state.

Free isn't exactly new to the space.

Obviously their offer may be a little bit broader.

I'm not familiar with all the details.

But we do have a free offer, as well.

Okay.

Got it.

That's helpful.

Thank you for your time.

The next question is from Michael Millman from Millman Research.

Thank you.

I wanted to follow something from actually last quarter and that's this definition of arresting the declines.

Sounds to me as you're actually saying you still expect declines.

The question is, what you mean is that your declines you expect in each of the first half and second of half will be less than last year?

And, secondly, how long do you think it will take before you reach the point where you're actually increasing returns in the first half and the second year?

And I have a couple other things.

What we were trying to indicate in our discussion was we had a large level of client decline last year.

It would be, in our view, unrealistic to think that in one year we would be able to move from losing clients to client growth.

We do think we will significantly reduce the client loss this year.

And we do believe that in the future -- and we haven't defined the future -- we will be at a position where we can grow clients in the assisted space.

Again, you're talking about both in the first half of the tax season and --?

Yes, we're talking about the total tax season, Mike.

In the total tax season.

Right.

In terms of reducing cost, are some of those costs coming from the preparers?

Are they having lower pay or different kinds of deals?

No.

No, that's not really a component of it.

It's more the full-time employees were impacted, as we disclosed in June, as well as a number of initiatives that we're no longer doing, as well as Bill mentioned the marketing reduction, as well.

No, we have not cut the pay of our tax pros.

And regarding the RALs and the same thing for the free EZs, you're doing what the rest of the industry is doing.

What was your thinking in not trying to -- obviously it's hard to be more aggressive than absolute zero, but in terms of assisted, having RALs at double 1250 and such.

I think what our approach is, is that we have been able to work with our bank partners and secure a very large amount of money of $1.65 billion.

We are going to be able to offer clients a range of advances from $500, $750 and $1,250 on a client by client basis.

So, we are looking to do a lot of loans to a lot of people and we will be marketing this aggressively.

Obviously there's an underwriting component of this that we work with our partners on.

You could argue we have a sweet spot.

Whether we could have been $50 more or not, I'm not -- I think we have a terrific offer.

I think we have terrific partners.

I think we have a great user experience that will be seamless.

It will be done at the desk.

You complete your taxes.

You're going to start the process right away.

We believe that we're going to be able to tell people -- we have to say, for legal reasons, within 24 hours, but we think a very large majority of those people will find out very quickly, within minutes to hours.

So, I think this is going to be a very exciting initiative for us in the way we have set it up.

What's your assumption as to the percentage of potential clients for RALs that will be accepted by the banks?

We haven't disclosed specific approval rates, but it's very favorable, from our perspective.

We think we went with an industry leading underwriter that can provide a very good indication of potential tax liens and therefore approve at a very high rate for both new and prior clients.

Thank you.

That was the last question at this time.

I will turn the call back over to the presenters.

Okay.

Thanks everyone again for joining us today.

And this will conclude today's call.

This concludes today's conference call.

You may now disconnect.